Mandatory Distribution: Meaning, Calculation, Example

What Is Mandatory Distribution?

Mandatory distribution refers to the minimum amount of money an individual must withdraw from certain types of tax-advantaged retirement accounts each year in order to avoid tax penalties. According to the Internal Revenue Service (IRS), the official name for mandatory distributions is required minimum distributions or RMDs.

Previously, RMDs started at age 70½, but that changed to age 73 or 75, depending upon the circumstances, with the December 2019 passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act and its follow-up, SECURE 2.0 in 2022.

Key Takeaways

• Mandatory distributions occur when an individual reaches the age required to take distributions from a retirement account.
• As of 2022, the age was increased to 73 years old (for account holders born between 1951 and 1959) or age 75 (for those born in 1960 or later) to take required minimum distributions from an IRA.
• The required minimum distributions for each account type are calculated differently.
• Excess withdrawals do not lower the required minimum distributions in future years.
• Mandatory distributions are included in an individual’s taxable income except for those that have already been taxed or that can be received tax-free.

How Mandatory Distributions Work

Mandatory distributions apply to traditional individual retirement accounts (IRAs), 401(k)s, 403(b)s, 457(b)s, SEPs, SARSEPs, SIMPLE IRAs, and Roth 401(k)s. They do not apply to Roth IRAs during the owner’s lifetime.

Once the age trigger is reached, the person must take mandatory distributions by December 31 each year. Otherwise, the IRS imposes stiff penalties: a tax of 25% on the amount that should have been withdrawn (that number can be reduced to 10% in some circumstances). However, exceeding the mandatory distribution is allowed.

Important

Mandatory distributions are taxed at an individual’s current marginal tax rate.

It’s important to note that in the first year of mandatory distributions, some retirees end up taking two years’ worth of distributions. This is because the IRS allows retirees to delay the first distribution until April 1 of the following year. This allows tax-advantaged investment returns to build up for a longer period of time.

Special Considerations

The rules for mandatory distributions change if the retirement account in question is inherited. There is also a difference based on the beneficiary’s relationship to the original account holder.

For a non-spouse, adult child, trust, or institution that inherits the account, the full account must be drawn down within 10 years. The 10-year rule is the result of the SECURE Act. Previously, non-spousal beneficiaries could have taken RMDs throughout their lifetime.

If the beneficiary is a spouse, a child under 18, or someone with a disability, they do not have to draw down the account balance within 10 years. Instead, they have the option to take mandatory distributions over their entire lifetime, as long as they begin within one year of the original owner’s death.

If you expect that you will be in a lower tax bracket when you retire, it is better to fund a retirement account today with pre-tax dollars rather than after-tax dollars.

Mandatory distribution amounts are based on the account balance and the account holder’s life expectancy, as determined by IRS tables. IRA custodians and plan administrators usually calculate RMDs for account holders, though technically, it is the account holder’s responsibility to determine the correct minimum distribution amount.

Workers who don’t own more than 5% of the company they work for are permitted by the IRS to postpone taking mandatory distributions from retirement accounts associated with that job until April 1 of the year after they retire.

How to Calculate a Mandatory Distribution

The amount of mandatory distributions is calculated separately for each account type. For an IRA, for example, take the account balance as of the previous December 31, then divide this by a so-called life-expectancy factor. The IRS includes these factors in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).

There are three different tables in the publication, based on different life situations. Choose the Joint and Last Survivor Table if you are the sole account beneficiary and are more than 10 years younger than your spouse. Choose the Uniform Lifeline Table if you have a spouse, but one who doesn’t fit the definition given in the Joint and Last Survivor Table. Finally, choose the Single Life Expectancy Table if you are the beneficiary of an account or an inherited IRA.

Example of Mandatory Distribution

Susan turned 73 this year and will have to take a mandatory distribution from her retirement account. She is unmarried and the balance of her retirement account as of December 31, the previous year, is $200,000. She consults the Uniform Life Table in Publication 590-B that tells her that her withdrawal factor is 25.6. She divides $200,000 by 25.6 to arrive at $7,812.5, which is her required mandatory distribution for the year.

What Types of Retirement Plans Require a Mandatory Distribution?

Most retirement plans are subject to mandatory distributions, including traditional individual retirement accounts (IRAs), 401(k)s, 403(b)s, 457(b)s, SEPs, SARSEPs, SIMPLE IRAs, and Roth 401(k)s. Roth IRAs are not subject to mandatory distributions during the owner’s lifetime.

What Is a Mandatory Distribution Calculator?

A mandatory distribution calculator is an online calculator, such as the one provided by the Securities and Exchange Commission (SEC), that allows an individual to quickly determine what their mandatory distribution is based on their age and account balance.

What Happens If You Fail to Take the Mandatory Distribution?

If you do not take the required mandatory distribution you will be charged a penalty of 25% on the amount that you were meant to take out. So, for example, if your required minimum distribution for the year was $4,000 and you failed to make the withdrawal, you would incur a penalty of $1,000.

How Are Mandatory Distributions Taxed?

Mandatory distributions are taxed at an individual’s tax bracket at the time of withdrawal. This only applies to distributions that have not already been taxed or that don’t qualify for taxation.

Does the Mandatory Distribution Affect Social Security?

Yes, mandatory distributions affect Social Security. Mandatory distributions count towards your combined income. Therefore, when you take distributions, your income increases, which could result in your Social Security benefits being taxed. If your combined income is between $25,000 and $34,000, up to 50% of your Social Security benefits could be taxed. If your combined income is more than $34,000, you can be taxed up to 85% of your SS benefits.

The Bottom Line

Mandatory distributions are the required amounts of money that an individual has to withdraw from their retirement accounts annually once they turn age 73 years old (for people born between 1951 and 1959) or age 75 (for those born in 1960 or later). The amount to be withdrawn depends on a variety of factors, such as age, and if distributions are not made, an individual will incur a hefty penalty. Mandatory distributions, also known as required minimum distributions (RMDs) apply to most retirement accounts, though some are exempt, such as Roth IRAs.

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