This biggest downsides of most tax advantaged retirement accounts are that you (1) can only contribute a maximum certain amount each year and (2) you can't withdraw the money to use without a tax penalty (expect in special circumstances) until you reach a certain age. However, there is another rule associated with these accounts that can be a perceived downside, for the opposite reasons as above. These are known as Required Minimum Distributions or RMDs.

Most investors early in their investing career think about required minimum distributions as a nice problem they hope to have someday. And that probably is the healthiest way to think about them.

However, once you near our reach retirement age, RMDs are something important to think about as you figure out your draw down strategy and look to make your nest egg last a long as possible.

So, let's take a deep dive into RMDs so that you are prepared no matter what stage in your investing career you currently reside!

Required Reading: If you aren't familiar with the various tax advantaged retirement accounts available to you, please review this quick guide first!

What are Required Minimum Distributions and how do they work?

An RMD is basically a certain amount of money that one must withdraw from certain types of tax advantaged retirement accounts by a certain age. If that appropriate withdrawal is not made by that certain age, and each year after, the IRS dishes out a penalty.

The first question that one usually asks after hearing this is, “how old do I have to be to start taking required minimum distributions?”

Thankfully the answer to this is generally easy. You have to take RMDs by April 1 of the year after you turn 73 or retire. After that first withdrawal, you need to make your RMDs by December 31st of each year thereafter.

There are some exceptions though.

First, for IRAs, it doesn't matter when you retire. You don't need to take an RMD until the year after you turn 73.

Second, for any defined contribution plan, like a 401k, if you work past age 73, you can delay taking RMDs until you retire. Unless you are a 5% or greater owner of the employer sponsoring the plan.

The next question is usually, “Well, which investment accounts do RMDs apply to?”

This is also pretty straightforward. The following retirement accounts are impacted by RMDs:

• 401(k)s
• 403(b)s
• 457s
• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs

You may notice a trend here: all of the retirement accounts that have RMDs are tax deferred accounts. This means that they are accounts that you put money in before taxation. And then taxes hit upon withdrawal.

And that is the exact reason that RMDs exist. Because the government doesn't want you to stretch your tax deferral forever and ever. An they definitely don't want you to do this until you die and then pass your accounts on to a beneficiary. At some point, Uncle Sam wants their cut of the tax pie. Therefore…required minimum distributions.

So, any sort of account with Roth treatment, in which you contribute money after taxation, does not have RMDs you need to worry about. Uncle Sam already got their taxes when you contributed to the account. So they really don't care much about when you withdraw money from it after that. So this includes Roth IRAs, Roth 401(k)s and so on.

The only time RMDs matter in Roth accounts is once the original owner dies and passes the account on. The beneficiary will eventually have to make RMDs.

What happens if you don't take RMDs?

Basically, the money that you should have taken out, but didn't, is taxed at 25%. This decreases to 10% if you withdraw the correct amount within 2 years. And this tax penalty goes on top of the income tax your withdrawal is already subject to.

Now comes the most confusing part…

How do you calculate how much of a required minimum distribution you need to make?

The simplest way to explain this is that you calculate your RMD by taking the account balance at the end of the calendar year preceding the RMD and divide it by a “distribution period” from the IRS “Uniform Lifetime Table.” This is basically an actuary lifespan table. And there are different ones for different scenarios like if your spouse is 10 years younger than you.

For most people, this “distribution period” factor number ranges from 27.4 down to 1.9. As a person gets older, the number goes down.

Luckily, there are worksheets available to help you figure this out for your individual case.

Your retirement plan custodian may calculate these figures for you. But ultimately it is your responsibility so make sure you are at least familiar with the calculations and how to do them.

And yes, you need to do this separately for every tax deferred account you have that is subject to RMDs at the appropriate time.

So now that we have the basics out of the way, let's take a practical look at things…

What do RMDs mean for doctors?

Like anything in personal finance, RMDs should not alone be a determining factor for just about any financial or life decision. They are simply part of the rulebook. It's our job to figure out how to use the rulebook to our best advantage.

I think the biggest things to understand about RMDs for each individual investor are:

• How much you will need to withdraw, and
• When you will need to start making the withdrawals

For most of us, this will start at age 73 and be based on our account size and distribution factor based on the IRS table shared above.

However, this information alone can help us determine the order in which we draw down from our investment accounts upon retirement. For instance, a doctor retiring in her 60s may decide to draw down on a taxable investment account or, better yet, a Roth IRA or 401(k) without RMDs first while letting her tax deferred accounts continue to grow until RMDs are necessary.

And remember, just because you have to take the distribution doesn't mean that you have to spend it. You can still save and invest it. While you can't transfer or convert your RMD to another retirement account, you can just take that money and invest it in a taxable investment account. This is a great way to keep your money working for you. Even after the government says you can't do it on their dime anymore!

The bottom line

Required minimum distributions are just another rule of the game and price we pay for the tax advantages in tax deferred retirement accounts. They are not necessarily a bad thing. But they are something we need to be aware of as we build our nest egg and progress on the path to financial freedom.

In my opinion, trying to delay RMDs as long as possible just for the sake of it doesn't make complete sense. FIRE or retire when you are ready. Because remember, the 4% rule of thumb works whether you retire at age 25 or 75 in theory. Withdrawing 4% of your nest egg should allow it to continue compounding and growing to stick around longer than you.

So it's less about the age at which you retire. And more about how you plan your withdrawals as your reach retirement. This may involve some Roth conversions in certain accounts if you are in a lower tax bracket so that you can stretch out your retirement accounts without worrying about RMDs. Or it might mean withdrawing from certain accounts before others.

This can be a bit complex and I think is a great reason to potentially engage a fee only advisor like these as you reach this stage of your investing career!

In the meantime, here are some great resources to help build up and optimize your nest egg along the way:

• How Much Do You Need to Save for a $5 Million Nest Egg?
• How the 4 Percent Rule Works (And If It Still Makes Sense for Doctors)
• What’s Better? Should You Pay Off Debt or Invest?
• The 7 Step Basic Formula for Wealth as a Physician
• 401k vs. Real Estate: Which Is the Better Investment?

What do you think? What is your plan for RMDs? Which retirement accounts do you have? Do they all have RMDs or no? What's your future draw down plan? Let me know in the comments below!