Simply put, a RMD is a way of making you withdraw money from your IRA or 401(k), whether you want to or not, so Uncle Sam can finally tax you on it.
How Required Minimum Distributions Work
You enter the land of required minimum distributions in the year in which you turn 70 1/2. In that year, you can take the withdrawal by the end of the year or wait until April 1 of the following year. After that, you must take your withdrawal each year by Dec. 31.
The rules work a little differently for IRAs and 401(k)s.
For IRAs -- and this applies only to traditional, SEP and SIMPLE IRAs, not to Roth IRAs -- you must base your withdrawals on the total value of all of your IRA accounts. (Roth IRAs don't count because you have already paid taxes on the money in them, and all the withdrawals are tax-free.)
If you have 401(k)s, you don't have to take withdrawals if you are still employed by the company. You do, however, if you are retired, or if you own 5% or more of the company. The withdrawal amount is based solely on the individual value of each 401(k) account. That means that if you hold money in more than one, you will have to calculate a separate withdrawal amount for each.
The amount is calculated according to your age, based on IRS estimates of life expectancy. You can find the actuarial tables in Internal Revenue Service Publication 590, or you can plug your numbers into an online calculator.
The Penalties for Failing to Take Your RMD
If you fail to take your withdrawals -- and the government will know because your accounts' custodians are required to report information to the IRS every year -- you will be hit with a whopping 50% fine on the withdrawal you failed to take, and you will still owe taxes on it. So if you're in the 28% tax bracket, and you fail to take a required $1,000 withdrawal, it'll cost you $780.
Minimizing the Impact of RMDs
Should you wait until April 1 of the following year to take that first withdrawal? Probably not. That means you would have to take two withdrawals in the same year, because you'll have to take withdrawal number two by Dec. 31. The extra withdrawal might push you into a higher tax bracket or make you ineligible for certain tax benefits.
If you pass your IRAs on to any heirs except your spouse, they will also need to take RMDs if they decide to keep your accounts intact, unless you leave them as Roth IRAs. Their withdrawal amounts will also be based on their ages.