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How to Calculate Retirement Fund Requirements

Updated on January 8, 2013

Minimum Distributions

Investors who have reached the age of 70 1/2 years old may or may not know that they are subjected to required distributions on their retirement accounts. These are commonly referred to by investment advisors as the Required Minimum Distribution (RMD). RMD's have numerous rules. However, the first rule is they apply only to pre-tax retirement accounts while ROTH IRA's are exempted. It is also important to note the term minimum. All account owners are permitted to take distributions in excess of the minimum.

Traditional & Rollover IRA's

These plans are subject to the standard mortality table that is used by the IRS which can be found in the IRS publication 590 found here.

Most financial institutions provide a more concise and easy to understand version of this table. All individuals must begin taking their RMD by April 1st following the year in which they turn 70 1/2 years of age. Individuals are permitted at times to defer the first years RMD, yet they must then take two distributions the following tax year and potentially increasing their tax liability as a result.

There are two factors that effect the amount of each years distribution. One is the closing market value of your IRA on December 31st of the prior year. The second factor is your age. As per the above Uniform life table, you are assigned a life expectancy figure by the IRS. You must then divide your account value from the year end by this figure. So for example, the first year's life expectancy as per the IRS at age 70 would be 27.4. So should your final account value be $350,000.00, this figure would be divided by 27.4.

$350,000.00 / 27.4 = $12,773.72 as your first years distribution.

Each year as you age the life expectancy factor declines and the rate of your distribution as a percentage of your account increases.

In cases where there is a spouse whom is more than 10 years younger than the account owner and is the sole primary beneficiary, the Uniform Life Table is substituted with the Joint Life Expectancy Table. This uses a different life expectancy table and slows the rate of distribution. Additionally it is important to understand that an RMD is based on the totality of your IRA retirement accounts. This does not mean the distribution must be realized from each account individually. Should an investor have 5 different IRA's held at different financial institutions, they are permitted to take the entire withdrawal from one account or any combination they wish. The one exception to this is a 403B. The 403B must be a separate and distinct distribution calculated and withdrawn independently.

401k, 403B and other Employer Sponsored Plans

In the case of these employer sponsered plans the rules are essentially the same in terms of the formula which is used. However, if you are over age 70 1/2 years of age and still employed with the firm that sponsors this plan, you are exempted from the mandated withdrawal until your employment is terminated. Yet if you have an IRA and are still employed the minimum distribution must still be taken.

Inherited IRA's & 401k Plans

In the event that you inherit a retirement plan from a deceased party, the rules depend on the relationship with the deceased party. If you are a spouse of the deceased you have the option of converting the IRA or 401k plan into an IRA of your own. In this case you are subject to the same rules, and not required to take the minimum until you attain the age of 70 1/2. One complication is that if you are a widow/widower under age 59 1/2, years of age, you would be subject to an additional 10% penalty on top of the taxable income if you needed to take the withdrawal. In such a case you may want to convert the inherited assets into an inherited IRA. This will mandate a distribution to you annually and allow you take penalty free withdrawals. Once you pass the age of 59 1/2 years of age you can still switch back to a traditional IRA under your name and waive the RMD until you reach age 70 1/2.

If you are a non-spouse and you've inherited retirement assets, you must use the SIngle Life Expectancy Table to calculate your minimum distributions. In this case there are once again multiple factors that are used. You must utilize the year end market value, date of death of the deceased and the Single Life Table.

If the IRA owner had designated multiple primary beneficiaries, then there are two possible scenarios for those beneficiaries. One scenario is for the beneficiaries to establish separate Inherited IRAs by December 31 of the year following the original IRA owner's death. If this occurs, then the RMD for each separate Inherited IRA will generally be based on each respective beneficiary's Single Life Table Each year thereafter. The other scenario is if the separate Inherited IRAs are not established by December 31 of the year following the original IRA owner's year of death. In this case, the RMD amount will generally be based on the oldest beneficiary's Single Life Expectancy for all accounts that did not separate by the deadline.

In the case of inherited accounts for a ROTH IRA, there is an RMD that must be taken as well under the same formula if the beneficiary is a non-spouse. Yet the ROTH continues to maintain it's tax free characteristics on the mandated distributions.

Taxes & Penalties

In the case of pre-taxed IRA accounts, all distributions will be reported as ordinary taxable income which will be taxed at your marginal income tax rate. It is prudent to address this in a timely manner. RMD's for inherited parties begin in the year following the passing of the deceased account owner. Those subject to an RMD because they have attained age 70 1/2 or inherited an account that fail to do so will be subject to a 50% annual penalty on the missed amount in addition to the ordinary income taxes.

Lastly, it is usually wise to work with your financial institution on calculating these distributions to double check your work. Many firms can now automate the payment of these RMD's electronically on your behalf to help minimize the risk of an error.


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