Required Minimum Distribution Basics

IRAs and qualified retirement plans are common means to save for retirement.  Because contributions to these accounts are generally tax-deferred, the IRS requires that distributions from these arrangements must generally begin by age 70 ½.  Roth IRAs are an important exception; distributions are not required during the lifetime of the owner who made the original contributions.

 

Year-end is an important time for individual tax planning. It is also a good time to consider how the required minimum distribution (RMD) rules may affect you, your plan participants, or your clients.

Here are some basic considerations regarding RMDs:

 

What is the individual’s age?

RMDs from a traditional IRA must start once an individual reaches age 70½. However, the rules are different for retirement plans. A retirement plan may allow for RMDs to be delayed until the later of age 70½ or termination, unless the participant owns more than 5% of the company. Individuals owning more than 5% of the company must start taking RMDs at age 70½, regardless of their employment status.

What are the consequences of taking two distributions in one year?

When an individual is required to start taking RMDs, he or she has the option of taking the first RMD by the end of the year for which it is due, or waiting and taking the first RMD by April 1st of the following year. Taking the first RMD in the year following the year it is due means the individual will take both the first and second RMDs in the same calendar year. Since RMDs are taxable distributions, the tax consequences of taking two RMDs in one year should be considered.

How many retirement accounts does the individual have, and what types of accounts are they?

RMDs are required from traditional IRAs, 401(k)/Profit Sharing plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to IRA-based qualified retirement plans such as SEPs and SIMPLE IRAs. While the original owner of a Roth IRA does not have to take RMDs, the beneficiary of the account is subject to distribution rules after the owner’s death.

For individuals with several traditional IRAs, all of the IRAs may be aggregated to calculate the total RMD, and then the total RMD may be taken from any or all of the various IRAs. Similarly, someone with more than one 403(b) account may aggregate and take just one RMD from one of those accounts. On the other hand, 401(k) or Profit Sharing plan accounts may never be aggregated with any IRA or even with another qualified plan account. The RMDs for each 401(k)/Profit Sharing plan must be calculated and distributed separately from each plan. Finally, it is not acceptable to take an IRA RMD from a 403(b) account or vice versa.

Is it desirable to take more than the RMD amount?

RMDs must be taken as cash distributions; they may never be rolled over into another tax-deferred account. However, it may be acceptable to take a distribution of amounts in addition to the RMD. The additional distribution may be rolled over if desired, but it may not be distributed and then counted toward an RMD for a subsequent calendar year. In terms of tax planning, if for some reason future taxable income or tax rates are expected to be higher, and there is reason to withdraw some or all of the account within the next year or two, it may benefit the account-holder to take additional distributions sooner rather than waiting for the next year’s RMD.

How are RMDs calculated?

\After the first RMD is taken, remaining RMDs are required by each December 31st. The RMD is calculated by dividing the account balance as of the valuation date (usually December 31st) for the prior calendar year by the applicable distribution period. A more in-depth discussion of the RMD calculation is beyond the scope of this article; there are many nuances regarding the calculation of RMDs, including accrued contributions, a first RMD that has been delayed, late RMDs, and the type and age of the account beneficiary. While the calculation for a typical account-holder with a spouse as beneficiary may be straightforward, it is important to seek an experienced advisor if there are questions about how to apply the rules.

What are the consequences of failing to take an RMD on time?

The IRS may impose a 50% excise tax on amounts that are not distributed, although there is an appeals process. If the amount of distribution taken during a calendar year is less than the RMD, only the shortfall is subject to the excise tax. The penalty may be waived if the individual can establish that a reasonable error was to blame and steps have been taken to timely distribute any future RMDs.

For additional information visit the IRS website.