The process of calculating your required minimum distribution (RMD) may appear to be complicated, but it is actually quite straightforward. Your yearly required minimum distribution (RMD) is calculated using a formula based on the Internal Revenue Service’s Uniform Lifetime Table.
For the most part, this table estimates the maximum number of years (also known as distribution periods) that your retirement account may require in order to make the required minimum distributions to you and your surviving spouse.
The table and the distribution periods associated with it are based on complex actuarial calculations of projected life expectancy estimates. Until 2021, the data in the table reflected life expectancy figures from the year 2012.
The Internal Revenue Service updated the table in 2020 to reflect its assumptions about longer life expectancies (this work was done before COVID-19, which reduced the average life expectancy for Americans by 1.8 years). These modifications were only put into effect on January 1, 2022.
What is the significance of this? Because longer life expectancies imply longer distribution periods, longer life expectancies are advantageous.
The distribution periods for those between the ages of 72 and 90, as shown in the table below, have increased from 2021 to 2022. As we’ll see, having longer distribution periods means that your required minimum distributions (RMDs) will consume a smaller percentage of your retirement assets.
Values are shifting.
Based on your age, your distribution period gets shorter and shorter with each passing year. For example, if you take your first required minimum distribution (RMD) in 2022 at the age of 72, your distribution period is 27.4 years long (vs. 25.6 years, based on the old table).
When you reach the age of 74, you will have lived for 25.5 years (vs. 23.8 years, based on the old table). When you reach the age of 80, you will have lived for 20.2 years (vs. 18.7 years using the old system).
Will you or your surviving spouse be reliant on your retirement assets to see you through this period? Maybe if you have a long life expectancy in your family.
It doesn’t matter how long you live, the distribution period is intended to ensure that RMDs don’t deplete the value of your retirement nest egg too early in your later years if you are fortunate enough to reach an advanced age.
Making your own RMD calculations
So, what is the formula for calculating your RMD for a given year? To calculate your RMD, divide the value of each retirement account at the end of each previous year by the distribution period that corresponds to your age in the year in which you take the RMD.
As shown in the table above, you can see how the updated distribution periods could theoretically affect your required minimum distributions (RMDs) in years past, as well as in 2022 and beyond.
In addition, you can use it to determine how much your required minimum distribution (RMD) would have been — or will be — at any given age between 72 and 90, depending on the value of one of your retirement accounts at the end of the previous year.
Here’s a very simple hypothetical example to illustrate my point. Consider the following scenario: your IRA was worth $500,000 at the end of 2021, and you will be 72 years old in 2022.
The IRS distribution period for people over the age of 72 is 27.4 years. As a result, dividing $500,000 by 27.4 years yields a result of $18,248. That would be your required minimum distribution (RMD) for 2022.
Let’s look at what would have happened if you had taken your first required minimum distribution (RMD) from your $500,000 IRA in 2021. The RMD would be $19,531 if you divided it by 25.6, which is $1,283 more than the RMD you would receive if you took your first RMD in 2022.
Just to be clear, even if you began taking RMDs years before 2021, your future RMDs will be calculated using the updated schedule beginning this year, and your RMDs will be lower than they would have been under the previous system.
In the event that you do not require your RMD to cover your cost of living, this is good news because, when all things are considered, lower RMDs could lower your taxable income — and allow you to keep more of your retirement money growing over time
Making informed decisions about RMD
The process of calculating annual RMDs is relatively straightforward. The part that can be difficult is determining which accounts should be used to transfer the funds.
It’s almost a no-brainer when it comes to 401(k) plan investments. The majority of plan providers will calculate your annual required minimum distribution (RMD) and make the distribution on your behalf if you are no longer an active participant in the plan (for example, if you have left the company or retired).
Other accounts provide you with greater flexibility and, as a result, a greater number of options to consider. Suppose you have several traditional or rollover IRAs, and you want to calculate the required minimum distribution (RMD) for each individual account.
A large number of IRA custodians will take care of this for you. The difficult part is deciding how much money to take out of each account at the same time..
You have the option of taking separate RMDs from each account.
You can withdraw the total combined RMD from a single checking account.
Alternatively, you can withdraw different amounts from several accounts that, when added together, equal the total amount of the RMD.
Finding creative ways to meet your required minimum distributions (RMDs) may spur you to reconsider how assets are invested in your retirement accounts.
In order to generate proceeds for RMDs, you may want to consider selling shares of asset classes (such as stocks) that currently account for a higher percentage of your asset class mix than your target asset class mixture. This will also assist you in rebalancing your investment portfolio.
Alternatively, you may wish to combine all of your various IRA and 401(k) accounts into a single rollover IRA with a custodian who will calculate your required minimum distributions (RMDs) for you.
Another option is to make a qualified charitable distribution of your annual required minimum distribution (RMD) directly from your IRA custodian to a qualified public charity, which will allow you to meet your RMD requirements without having to pay taxes on them.
All of these scenarios have implications for your retirement income and tax planning that are not always straightforward to determine on your own. Working with an accountant and a financial adviser can assist you in determining which distribution strategies are most appropriate for your company.