When you turn 72, the IRS requires you to start withdrawing money from your 401(k) each year. These withdrawals are called required minimum distributions (or RMDs), and it’s important to understand how they work because if you don’t withdraw the correct amount by Dec. 31 of each year, you could get hit with a big penalty.

The RMD rules also apply to other tax-deferred accounts, including traditional IRAs, SIMPLE and SEP IRAs. You don’t have to take RMDs from a Roth IRA — unless it’s inherited or it’s a Roth 401(k).

To avoid any confusion — and a potentially hefty penalty — keep reading to understand the ins and outs of RMDs.

Related: Top 10 must-know rules on 401(k) taxes

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What Is an RMD?

While many 401(k) participants know about the early withdrawal penalties for 401(k) accounts, fewer people know about the requirement to make minimum withdrawals once you reach a certain age. These are called required minimum distributions or RMDs, and they apply to most tax-deferred accounts.

Prior to 2019, the age at which 401(k) participants had to start taking RMDs was 70-and-a-half. The rule changed in 2019 and the required age to start RMDs is now 72.

When you turn 72 the IRS requires you to start taking withdrawals from your 401(k), or other tax-deferred accounts. If you don’t you could face another requirement: to pay a penalty of 50% of the withdrawal you didn’t take.

All RMDs from tax-deferred accounts like 401(k) plans are taxed as ordinary income. If you withdraw more than the required minimum, no penalty applies.

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Why your first RMD is different

There is a slight variation in the rule for your first RMD: You actually have until April 1 of the year after you turn 72 to take that first withdrawal. For example, say you turned 72 in 2021. You would have until April 1, 2022, to take your first RMD.

But you would also have to take the normal RMD for 2022 by Dec. 31 of that year, thus potentially taking two withdrawals in one year.

Since you must pay ordinary income tax on the money you withdraw from your 401(k), just like other tax deferred accounts, you may want to plan for the impact of two taxable withdrawals within one calendar year if you go that route.

Why does the government require these withdrawals? Remember: All the money people set aside in defined contribution plans like traditional IRAs, SEP IRAS, SIMPLE IRAS, 401(k) plans, 403(b) plans, 457(b) plans, profit-sharing plans and so on, is deposited pre-tax. That’s why these accounts are typically called tax-deferred: the tax you owe is deferred until you retire. So requiring people to take a minimum withdrawal amount each year is a way to ensure that taxes get paid on the money.

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RMD Rules for 401(k) Plans

So just to recap, here are the basic RMD rules for 401(k) plans. Because these rules are complicated and exceptions may apply, especially in light of COVID, it’s wise to consult with a professional.

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At what age do RMDs start?

You must take your first RMD the same year you turn age 72. For your first RMD only, you are allowed to delay the withdrawal until April 1 of the year after you turn 72.

This is a mixed blessing however, because the second RMD would be due on Dec. 31 of that year as well. For tax purposes, you might want to take your first RMD the same year you turn 72, to avoid the potentially higher tax bill from taking two withdrawals in the same calendar year.

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What are the RMD deadlines?

Aside from the April 1 deadline available only for your first RMD, the regular deadline for your annual RMD is Dec. 31 of each year. That means by Dec. 31 you must withdraw the required amount, either in a lump sum or in smaller increments over the course of the year.

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How do I know the right amount of my RMD?

The amount of your RMD is determined by tables created by the IRS based on your life expectancy, and the age of your spouse, if you’re married. If your spouse is more than 10 years younger than you, or less than 10 years younger, the calculation is slightly different (more details below).

You’re not limited to the amount of your RMD, by the way. You can withdraw more than the RMD amount at any point. These rules are simply to insure minimum withdrawals are met.

If you withdraw more than the RMD one year, it does not change the RMD requirement for the next year.

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Penalties

The basic penalty, if you miss or forget to take your required minimum distribution from your 401(k), is 50% of the amount you were supposed to withdraw. Let’s say you were supposed to withdraw a total of $10,500 in a certain year, but you didn’t; in that case you could potentially get hit with a 50% penalty, or $5,250.

But let’s say you’ve taken withdrawals all year, but you miscalculated and only withdrew $7,300 total. Then you would owe a 50% penalty on the difference between the amount you withdrew and the actual RMD amount: $10,500 – $7,300 = $3,200 x .50 = $1,600

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Did COVID Change RMD Rules?

Owing to a strange overlap, there was an RMD rule change that raised the required age to 72, but this coincided with a suspension of all RMDs in 2020 owing to COVID. Here’s what happened, and what that means for your RMDs now.

• First, in 2019 the SECURE Act changed the required age for RMDs from 70½ to 72, to start in 2020.
• But when the pandemic hit in early 2020, RMDs were suspended entirely for that year under the CARES Act. So, even if you turned 72 in the year 2020 — the new qualifying age for RMDs — RMDs were waived.

The waiver also applied to those who were RMD-eligible in 2019 but planned to take their first RMDs by April of 2020.

As of early 2021, though, required minimum distributions were restored. So, here’s how it works now, taking into account the 2020 suspension and the new age for RMDs:

• If you were taking RMDs regularly before the 2020 suspension, you need to resume taking your annual RMD by Dec. 31, 2021.
• If you were eligible for your first RMD in 2019 and you’d planned to take your first RMD by April 2020, but didn’t because of the waiver, you must take that RMD by Dec. 31, 2021.
• If you turned 72 in 2020, and are taking an RMD for the first time, then you’d have until April 1, 2022, to take that first withdrawal. (But you can take that first withdrawal in 2021, to avoid the tax burden of taking two withdrawals in 2022.)
• Remember that whenever you choose to take your first RMD, whether it’s the year you turn 72 or the April of the year after, all subsequent RMDs are due on Dec. 31 each year.

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How Are RMDs Calculated?

401(k) RMDs are calculated by dividing the account balance in your 401(k) by what is called a “life expectancy factor,” which is basically a type of actuarial table created by the IRS. You can find these tables in Publication 590-B.

If you’re married, there are two different tables to be aware of. If you are the original account owner and if your spouse is up to 10 years younger than you, or is not your sole beneficiary, you’d consult the IRS Uniform Lifetime Table.

If your spouse is the primary beneficiary, and is more than 10 years younger, you’d consult the IRS Joint and Last Survivor table. Here, the RMD might be lower.

So, how does the life expectancy factor work?

Let’s say a 75-year-old has a life expectancy factor of 22.9, according to the IRS. If that person has a portfolio valued at $500,000, they’d have to take an RMD of $21,834 ($500,000/22.9) from their account that year.

RMDs can be withdrawn in one sum or numerous smaller payments over the course of a year, as long as they add up to the total amount of your RMD requirement.

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RMDs when you have multiple accounts

If you have multiple accounts — such as a 401(k) and two IRAs — you would have to calculate the RMD for each of the accounts to arrive at the total amount you’re required to withdraw that year. But you would not have to take that amount out of each account. You can decide which account is more advantageous and take your entire RMD from that account or divide it among your accounts by taking smaller withdrawals over the course of the year.

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Allocating your RMDs

Individuals can also decide how they want their RMD allocated — for example, some people take a proportional approach to RMD distribution. This means a person with 30% of assets in short-term bonds might choose to have 30% of their RMD come from those investments.

Deciding how to allocate an RMD gives an investor some flexibility over their finances. For example, it might be possible to manage the potential tax you’d owe by mapping out your RMDs — or other considerations.

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Do Roth 401ks Have RMDs?

Yes, Roth 401(k) plans do have required minimum distributions — and this is an important distinction between Roth 401(k)s and Roth IRAs. Even though the funds you contribute to a Roth 401(k) are already taxed, you are still required to make RMDs, following the same life expectancy factor charts provided by the IRS for traditional 401(k)s and IRAs. The difference being, you don’t owe taxes on the RMDs from a Roth 401(k).

If you have a Roth IRA, however, you don’t have to take any RMDs. And if you inherit a Roth IRA from your spouse, it’s considered your own account and RMDs don’t apply.

The rule changes, though, when it’s a Roth IRA that you’ve inherited from someone who wasn’t your spouse (e.g. a parent or other relative). In that instance, you must withdraw all the funds within 10 years of the inheritance.

Because the rules surrounding inherited IRAs can be quite complicated, it’s wise to get advice from a professional.

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Can You Delay Taking an RMD From Your 401(k)?

As noted above, there is some flexibility with your first RMD, when you turn age 72. You can delay your first RMD until April 1 of the year after you turn 72. (Just remember that your second RMD would be due by Dec. 31 of that year as well, so you’d be taking two taxable withdrawals in the same year.)

Also, if you are still employed by the sponsor of your 401(k) (or other employer plan) when you turn 72, you can delay taking RMDs until you leave that job or retire.

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RMD Requirements for Inherited 401(k) Accounts

Don’t assume that RMDs are only for people in or near retirement. RMDs are usually required for those who inherit 401(k)s as well. The rules here can get complicated, depending on whether you are the surviving spouse inheriting a 401(k), or a non-spouse. In most cases, the surviving spouse is the legal beneficiary of a 401(k) unless a waiver was signed.

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Inheriting a 401K) from your spouse

If you’re the spouse inheriting a 401(k) you can rollover the funds into your own existing 401(k), or you can rollover the funds into what’s known as an “inherited IRA” — the IRA account is not inherited, but it holds the inherited funds from the 401(k). Then you would take RMDs from these accounts when you turned 72, based on the IRS tables that apply to you.

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Inheriting a 401(k) from a non-spouse

If you inherit a 401(k) from someone who was not your spouse, you must rollover the funds into an inherited IRA. And, owing to a rule change in the SECURE Act, you would be required to withdraw the money within five or 10 years, depending on when the account holder died.

The five-year rule comes into play if the person died in 2020 or before; the 10-year rule applies if they died in 2021 or later.

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Other restrictions on inherited 401(k) accounts

Bear in mind that the company which sponsored the 401(k) may have restrictions on how inherited funds must be handled. In some cases, you may be able to keep 401(k) funds in the account, or you might be required to withdraw all funds within a certain time period.

In addition, state laws governing the inheritance of 401(k) assets can come into play.

If you’ve inherited a 401(k), it’s probably best to consult a professional who can help you sort out your individual situation.

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How to Avoid RMDs on 401(k)

While a 401(k) grows tax-free during the course of an investor’s working years, the RMDs withdrawal is taxed at their current income tax rate. One way to offset that tax liability is for an investor to consider converting a 401(k) into a Roth IRA in the years preceding mandatory RMDs. Roth IRAs are not subject to RMD rules.

A Roth conversion can be done at any point during an investor’s life, and can be done with all of the 401(k) funds or some of the money.

Because a 401(k) invests pre-tax dollars and a Roth IRA invests after-tax dollars, you would have to pay taxes right away on any 401(k) funds you converted to a Roth. But the good news is, upon withdrawing the money after retirement, you don’t have to pay any additional taxes on those RMDs.

Paying your tax bill now rather than in the future can make sense for investors who anticipate being in a higher tax bracket during their retirement years than they are currently.

Converting a 401(k) can also be a way for high earners to take advantage of a Roth. Traditional Roth accounts have an income cap. To contribute the maximum to a Roth IRA in 2022, your modified adjusted gross income (MAGI) must be less than $129,000 if you’re single, less than $204,000 if you’re married filing jointly, with phaseouts if your income is higher. But those income rules don’t apply to Roth conversions (thus they’re sometimes called the “backdoor Roth” option).

Once the conversion occurs and a Roth IRA account is opened, an investor needs to follow Roth rules: In general, withdrawals can be taken out after an account owner has had the account for five years and the owner is older than 59-and-a-half, barring outside circumstances such as death, disability or first home purchase.

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What Should an Investor Do With Their RMDs

How you use your RMD depends on your financial goals. Fortunately, there are no requirements around how you spend or invest these funds (with the possible exception that you cannot take an RMD and redeposit it in the same account).

Some people may use their RMDs for living expenses, especially if they are in their retirement years. If you plan to use your RMD for income, it’s also smart to consider the tax consequences of that choice in light of other income sources like Social Security.

Other people may use their 401(k) RMDs to fund a brokerage account and continue investing. While you can’t take an RMD and redeposit it, it’s possible to directly transfer your RMD into a taxable account. You will still owe taxes on the RMD, but you could stay invested in the securities in the previous portfolio.

Reinvesting RMDs might provide a growth vehicle for retirement income. For example, some investors may look to securities that provide a dividend, so they can create cash flow as well as maintain investments.

Investors also may use part of their RMD to donate to charity. If the funds are directly transferred from the IRA to the charity (instead of writing out a check yourself), the donation will be excluded from taxable income.

While there is no right way to manage RMDs, coming up with a plan can help insure that your money continues to work for you, long after it’s out of your original 401(k) account.

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The Takeaway

Investors facing required minimum distributions from their 401(k) accounts may want to fully understand what the law requires. First, there are hefty penalties for not withdrawing the correct amount each year. Second, changes to RMD rules in 2019, thanks to the SECURE Act, raised the starting age to 72, from 70½ — and this, on top of the 2020 suspension of RMDs owing to COVID, have made RMD deadlines this year a little more complicated, especially if you’re just starting to take RMDs.

Even if you’re not quite at the age to take RMDs, you may want to think ahead so that you have a plan for withdrawing your assets that makes sense for you and your loved ones. It can help to walk through the many different requirements and options you have as an account holder, or if you think you might inherit a 401(k).

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