After a certain age, you must begin to take minimum withdrawals from your tax-advantaged retirement accounts. The exact amount of this required minimum distribution or RMD is determined by a number of factors, including your age and the amount you have saved up.
The IRS requires you to report this distribution on your annual taxes, so it has to happen by the end of each calendar year. Beyond that, though, you can structure this withdrawal based on your own financial interests. Most retirees collect their required minimum distributions either annually, quarterly or monthly. So long as you withdraw the minimum required amount by Dec. 31, the tax implications are unchanged.
Let’s consider your options.
A financial expert could help you create a financial plan for your retirement needs and goals.
What Is the Required Minimum Distribution?
A required minimum distribution is the amount of money you must withdraw each year from a tax-advantaged retirement account. You can take out more than your RMD, but you must withdraw at least this much each year. The amount of your required minimum distribution is determined by your age and savings, and taxpayers can calculate it each year using the IRS’ Uniform Lifetime Table.
For anyone who turned 70 on or after July 1, 2019, required minimum distributions begin at age 72. For all retirees who turned 70 before July 1, 2019, required minimum distributions begin at age 70 and six months.
The purpose of a required minimum distribution is so that the IRS can eventually collect the taxes that it deferred when you made contributions to your various retirement accounts. It applies to accounts such as 401(k)s, IRAs and almost any other form of retirement account on which you don’t pay taxes. The only significant exceptions are Roth IRAs and other similarly situated accounts.
You must calculate a required minimum distribution for each retirement account in your name. This means that if you have three different qualifying retirement accounts, you must calculate the required minimum distribution for all three accounts. If you fail to withdraw (and pay taxes) on a required minimum distribution, you can be taxed at up to 50% of the required amount. (For example, if you were required to withdraw at least $10,000 and did not do so, you can face a tax bill of up to $5,000.)
You can use an RMD, however, you see fit; the government just wants to make sure you eventually pay taxes on this money. The only restriction is that you cannot reinvest it in a tax-advantaged retirement account other than, in some cases, a Roth IRA.
Annual Withdrawals
An annual withdrawal plan means that you calculate and withdraw your required minimum distribution in one lump sum each year. This is a perfectly acceptable approach to accounting, since your required minimum distribution is set by a pre-determined formula. You calculate it based on the value of your retirement accounts as of Dec. 31 the year before and using the Uniform Lifetime Table that the IRS releases for each year’s tax filings.
So, for example, to calculate your required minimum distribution in 2022, you would use the value of your retirement accounts as of Dec. 31, 2021 and the Uniform Lifetime Table applicable to 2022.
Most taxpayers who choose to make annual withdrawals do so either at the beginning or at the end of each tax year. This is a matter of personal accounting since you can withdraw this money at any time. The one exception is that in the first year that you qualify for a required minimum distribution, you must begin making these withdrawals by April 1. For all years afterward the IRS has no deadline other than end of year.
Whenever you choose to withdraw your minimum distributions, there are pros and cons to the annual approach. The benefits to annual withdrawals can include:
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Immediate resolution of your tax obligations. By withdrawing all of your required minimum distribution at once, at the start of the year, you get your tax obligation over with. You don’t have to worry about forgetting or otherwise making a mistake during the rest of the year.
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Reinvestment opportunities. If you have other strong investments, you can take your minimum distribution and invest it in those opportunities earlier, with more time for growth.
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Potentially better growth. Since this is a tax advantaged account, the sooner you withdraw this money the sooner you pay taxes on it. By contrast, the longer you leave it alone the longer it can grow tax-free. Withdrawing it all at the end of the year can mean more growth in your retirement account over the long run. This is the biggest advantage to making annual withdrawals.
However, there are some downsides to annual withdrawals too. Those can include:
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Potentially higher estimated taxes. If you pay taxes quarterly, for example if you own a business or generate self-employment income, you can significantly increase your estimated taxes by taking an early minimum distribution.
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Cash flow disruption. Some people need the structure of a regular income for their financial planning purposes, which a lump sum withdrawal can disrupt.
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Potentially forgetting. If you wait until the end of the year to make your minimum distribution, there’s a chance you’ll forget to do so altogether.
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Risk of spending the tax money. When you withdraw money from your retirement account, you must pay taxes on the profits that account has accrued. If you take your RMD early in the year, there’s a risk that you will spend the portion of that money that you will later need to pay taxes. (This depends on how you structure your account, as some retirement accounts will automatically withhold taxes on your behalf.)
Monthly/Quarterly Withdrawals
The other common approach to required minimum distributions is for retirees to take this money either every month or every quarter. As with annual distributions, there is no best way to handle this money. Some retirees prefer taking a lump sum distribution each year. Others prefer a series of smaller monthly withdrawals. It’s all up to you.
Readers should note that even this is not the only option. You can make distributions as frequently as your portfolio will allow transfers. However, monthly is the most frequent common approach.
The benefits to a monthly or quarterly approach can include:
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Cash flow management. Making monthly withdrawals allows you to treat this as a regular income. Many retirees prefer this style of cash flow over a lump sum format, as it helps with personal finance and budgeting. This is often the biggest advantage to making monthly or quarterly withdrawals.
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Estimated taxes. As noted in our section on annual withdrawals, if you pay quarterly taxes based on other income, having your required minimum distribution arrive in regular segments can make these estimated taxes easier.
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Tax payments. If you make monthly withdrawals, it’s often easier to have your portfolio manager automatically deduct any applicable income taxes so that you don’t have to worry about setting the money aside.
Some potential downsides to a monthly or quarterly approach can include:
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Reduced growth. The longer you leave your money in place, the more it can grow. If you take your withdrawals over the course of the year, your portfolio will lose some opportunities growth based on reduced capital.
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Potential for miscalculation. While less of a concern if you work with a professional, if you withdraw your money in stages (rather than one lump sum) there’s more chance that you’ll miscalculate or otherwise make a mistake in your minimum withdrawal.
Ultimately, this comes down to the choice that’s best for your finances. In most cases we can recommend framing the issue this way: Your money has the most potential for growth if you take your entire minimum distribution at the end of each calendar year. However, personal budgeting may be easiest if you take your minimum distribution in 12 monthly portions.
If you do take your minimum distribution at the end of the calendar year, make sure you set up an automatic withdrawal. Even professional brokers can get distracted around Christmas and New Year’s, and you don’t want to discover that your sell order got held up by the holidays.
Bottom Line
You can take your required minimum distribution at any point, so long as it happens before the end of the year. Most retirees either take their money in one lump sum at the end of the year, to give it the most time to grow tax-free. Others withdraw their money each month, to give themselves a regular stream of income.
Tips for Retirement Planning
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According to the Federal Reserve, 60% of those with self-directed retirement accounts are not confident about their investment decisions. If you’re one of them, why not hire a financial advisor? SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Getting the RMD right is extremely important. The tax implications for this are huge, with potential liability up to 50% of the entire amount. So make sure you know how to calculate your required minimum distribution.
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