If you have a tax-deferred retirement savings plan, like a 401(k) or a traditional IRA, then you know that once you reach age 70 1/2, you’ll have to begin taking a Required Minimum Distribution (RMD) from your account each year. Very basically, the amount of your RMD is equal to your account balance divided by your life expectancy. It’s different each year, and if you don’t withdraw the correct amount on an annual basis, you’ll pay a penalty to the IRS.
The Reason for RMD’s
Why is an RMD required for these accounts? Because they’re tax-deferred. Since you don’t pay taxes on money when you contribute it to the account, you’re instead taxed on money when you withdraw if from the account. So, to make sure you pay at least a minimum amount of income tax on the account funds, the government imposes a Required Minimum Distribution.
Roths are Different
Roth IRA’s are different, though. Instead of being tax-deferred accounts, they’re tax-free accounts. When you have a Roth IRA, you make contributions with money that’s already been taxed. Later, when you retire, withdrawals you make in accordance with the rules of your account are not taxable.
Because Roth IRA contributions, instead of withdrawals, are taxed, the government does not impose a Required Minimum Distribution rule on these accounts. This makes Roth IRAs a great option for people who want to use their retirement account to pass on wealth to their children or grandchildren, instead of using the account to fund their own retirement.