In general, the concept of an individual retirement account is relatively easy to understand, even for individuals who haven’t yet opened an account for themselves. The IRA lets you save money for retirement by making investments of your choosing (and self-directed IRAs provide even more options in this regard) and you’ll receive certain tax benefits as part of owning an account.
But some aspects of the IRA are fairly new to some people in the first open an account. One of the most potentially confusing concepts is the IRS rules on required minimum distributions (or “RMDs”). Here are some tips for navigating and staying on the right side of the rules.
What is the General Rule for Required Minimum Distributions?
The IRS requires that once the owner of a traditional IRA reaches age 70½, that individual must begin taking distributions from their account. These distributions are subject to a required minimum (which is calculated on the basis of the individual’s life expectancy and account balance), and must be made each and every year. There are several important points to recognize when it comes to this rule.
Roth IRAs Aren’t Covered.
Perhaps most significant rule is that the RMDs only apply to traditional accounts. Roth IRAs are not subject to the RMD rules. This means that an account holder can continue to let their Roth IRA grow for many years into retirement. For retirees who have multiple sources of retirement income (Social Security, 401(k)s, other IRAs, etc.), this can be a great way to maximize their overall nest egg.
In addition, since different types of IRAs – particularly Roth accounts – can be used to achieve various estate planning goals, the fact that Roth accounts are not subject to the rules for RMDs makes them especially attractive savings vehicles.
The RMD Amounts are Only Minimums.
The rules on RMDs don’t exist for the purpose of creating a withdrawal schedule that you must follow during retirement. The amount that is calculated as the required minimum for any given year is just that; a minimum. You are always free to take out more than the RMD amount from your account each year.
The RMD Amounts Change.
Furthermore, because the RMD amount is based in part upon the balance in your account, your investment performance can significantly change the RMD amount from one year to the next. As your account grows, for example, the amount might actually increase significantly from one year to the next.
Self-Directed IRA Considerations.
Special considerations must be given to these rules if you choose to structure your self-directed IRA as a traditional account. Consider how you will satisfy the RMD rules each year once you enter retirement. For example, if your account investment portfolio is comprised largely of real estate, will you need to liquidate any of your holdings in order to meet your obligations?
If you find that satisfying the rules for RMDs from a traditional self-directed IRA may be too onerous, remember you can always evaluate the possibility of converting to a Roth account.