Required Minimum Distributions (RMD)
The rules for Required Minimum Distributions (RMD) need to be clearly understood to avoid paying unwanted and unnecessary penalties to our friends at the Internal Revenue Service.
This is a quick guide of the rules, however please be sure to discuss the particulars of your circumstances with a qualified Professional.
The calendar year you turn 70 ½ is the first year you must calculate your Required Minimum Distribution (RMD). If you were born between January 1st and June 30th, the year you turn 70 will be your first Required Distribution year. If you were born between July 1st and December 31st, the following year after you turn 70 will be your first Required Distribution year.
You must either withdraw your first year RMD by the end of that year or elect a “one-time postponement”.
RMD – One Time Postponement
The law says that you can postpone your 1st year Required Minimum Distribution until April 1st of the year after the year you turn 70 ½. If you elect to do so, you will need to take 2 Distributions in the following year, one for the previous (1st RMD) year and one for the current year. The reason some taxpayers elect to do this is because their income will be dropping the year they take 2 Distributions, perhaps because of retirement. Otherwise, it makes sense to take the 1st year’s Distribution in the year you turn 70 ½.
RMD – The Exception
If you are working when you turn 70 ½ and have a 401K Plan with that company, typically you do not have to take an RMD from that 401K provided you are not a 5% or more owner of that company. You can also rollover any other 401K Plans to your current companies plan and perhaps even your IRA’s. This will enable you to postpone your RMD until you retire.
Interestingly, there is no available guidance about how many hours one needs to work to be deemed “working”.
The caveat is that your current companies 401K must have this spelled out in the Plans Summary Plan Description (SPD) which is typically found on your 401K or Plan sponsored website.
I’m not suggesting this is advantageous, however for some taxpayers this may make tax sense.
RMD – The Calculation
For each and every Retirement Account, you must calculate the RMD Requirement. For most Retirement Accounts, you’ll simply divide your account balance, as of the last day of the previous year, by your IRS provided Life-Expectancy factor. Your 12-31 previous year-end account value ÷ Life-Expectancy factor equals your RMD for that account. Please click here, 2019 Key Financial Data and see page 2 for the Life-Expectancy factors under the Uniform Lifetime Table.
For those of you that have Retirement Account Annuities, the calculation is not that simple. If you have any additional benefits or riders attached to your Annuity, you need to call the Annuity company and have them calculate your RMD as the “additional benefits or riders” attached to your Annuity contract typically increase the amount of your RMD requirement annually.
RMD – Aggregation Rules
Is it a requirement that you withdraw each RMD from each account? The answer is yes and no.
For example, if you have 3, IRA accounts, you must calculate the RMD requirement separately for each account, however you can take the sum total from any one or any combination of your IRA’s.
If you have 3, 401K accounts, you must calculate your RMD requirement separately for each account and you MUST take them separately from each account.
If you have 3, 403B accounts, you must calculate your RMD requirement separately for each account, however you can take the sum total from any one or any combination of your 403b’s.
If you have 1, IRA, 1, 401K and 1, 403B, you must calculate your RMD separately for each and also take the RMD separately from each account.
RMD – The Penalty
The penalty for not taking your full RMD will be 50% of the amount that you failed to withdraw. Of course, there will be interest penalties associated and can be calculated to accumulate indefinitely.
RMD – Penalty Relief
This is one area of the tax code, the IRS has the ability to waive the penalty, the first time. Once you realize you missed your RMD, I would suggest immediately meeting with a good Financial Advisor or CPA. You want to have the RMD Requirement calculated and then distributed to you immediately. Your CPA will then file IRS Form #5329 for each year the RMD was missed and you’ll write a letter of explanation as to why you did not take the RMD. In many cases, the IRS has elected to waive the penalty the first time.
However, with tax revenues decreasing and government funding costs increasing, relief may not be available at some point in the future.
Should you wait until 70 ½ to begin distributing your IRA or should you do so sooner?
In many cases, if one delays until age 70 ½, the Required Minimum Distribution for the year is larger than the persons consumption needs. The additional non-needed part of the Distribution may place you in a higher Marginal Tax Bracket, increase the taxation on your Social Security Benefits and increase your premiums for Medicare Parts B and D.
If you retire prior to age 70 ½ and your income drops, an analysis is recommended to compare the benefits of delaying until 70 ½ and then comparing to taking IRA Distributions each year prior to age 70 ½, using the technique of “filling up the tax bracket”. By taking IRA Distributions sooner, upon reaching age 70 ½, your RMD Requirement will be less. Reducing your RMD Requirement from age 70 ½ for the rest of your life, may save you significant tax money and avoid you having to pay the Medicare Income related additional premiums.
We discuss IRA Distribution Tax Planning techniques in depth at our Retirement Income/Tax Planning Workshops. For a listing of our upcoming Workshops, please click here Retirement Income/Tax Planning Workshop.