Individuals who are approaching age 70 need to be aware of the required minimum
distribution (“RMD”) rules related to retirement accounts. To avoid indefinite tax
deferral, it is generally required that an individual takes distributions from his/her
retirement accounts beginning in the year that the individual turns 70 ½.
How is the RWD calculated?
The RMD is calculated based on each of the retirement account balances at
the end of the previous year, divided by a factor from Uniform Lifetime Tables published by
the Internal Revenue Service (IRS) in Appendix B of Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). Table I is for use by beneficiaries, Table II should be used if the spouse is the sole beneficiary and the spouse is more than 10 years younger than the deceased, and Table III should be used by unmarried owners, married owners whose spouses are not more than 10 years younger and married owners whose spouses are not the sole beneficiaries of their IRAs. The factor is reduced by one for each subsequent year.
An individual must withdraw at least the required amount, but can withdraw more as needed. These withdrawals are included in taxable income in the year withdrawn, with the exception of distributions from ROTH IRAs and ROTH 401(k)’s, which are not taxable since they are funded with after-tax dollars. The excess withdrawals in any year cannot offset RMDs for future years.
Who calculates the RMD?
There are several ways to determine the value at the end of the year for purposes of the RMD calculation. Form 5498, IRA Contribution Information, is provided each year to IRA holders by the financial institution holding the IRA funds. This form shows the IRA contributions, required minimum distribution (amount and date) and the fair market value of the account at year end. The IRA holder should also save the December 31 statement from each of his/her retirement accounts. The RMD may be calculated in a footnote, but at a minimum, the statement will provide the year end value.
The financial institution where the retirement funds are held will often contact the individual when he/she is approaching age 70 ½ with an explanation of how the rules work and an offer to calculate the RMD. A representative from the financial institution may also contact the individual’s accountant for assistance in calculating the RMD.
The plan sponsor or administrator of a company sponsored defined contribution plan should
calculate the RMD for the individual. There is no RMD penalty assessed to the employer for a missed RMD, but the plan risks becoming disqualified and losing its exempt status if the RMD rules are not followed. Therefore, the plan administrator should be monitoring the birthdates of the plan participants and notifying them when it is time to take an RMD.
The responsibility of taking the RMD ultimately remains with the individual, however, so it is up to the individual to follow up with the custodian if no information has been received regarding the RMD calculation.
When does the first RMD from an IRA have to be taken?
In the year that the individual turns 70 ½, there are two options for an RMD from an IRA: 1) the
individual can take the first RMD by December 31 of that year or 2) the individual can delay the first RMD up to April 1 of the following year. Subsequent RMDs must be taken by December 31 each year, so delaying the first distribution to the following year will cause two RMDs to be taxed in the following year. Taking two RMDs in one year could cause the individual to be in a higher tax bracket, make more social security benefits taxable, and could increase the phaseout of itemized deductions. RMDs from IRAs are required whether or not the individual is retired, and these RMD rules apply to Simplified Employee Pension or Simple IRAs.
Does the RMD have to be taken out of each IRA?
No, the RMD calculation must be done for each IRA separately, but the aggregate RMD for the year can be taken out of one account only or any combination of IRA accounts to simplify the withdrawal process. The key is to have the correct total RMD for the year.
Should federal and state withholding taxes be automatically deducted from the RMD?
Everyone’s tax situation is different, but it may be beneficial to have the custodian withhold federal and possibly state income taxes from the distribution to avoid an unexpected tax bill the following April when filing income tax returns. The custodian allows the beneficiary to specify the withholding percentages. Retirement income is not taxable in all states, so a beneficiary may only need to withhold federal income taxes.
When does the first RMD from a company sponsored defined contribution
plan such as a 401(k) or profit sharing plan have to be taken?
RMDs from company sponsored defined contribution plans must generally be made by April 1
following the later of 1) the year the individual turns 70 ½ or 2) the year the individual retires. However, a 5% or more owner must begin RMDs by April 1 of the year following the year the individual turns 70 ½, even if not retired. Ownership by family members such as spouse, children, grandchildren and parents must be considered in determining the 5% ownership threshold.
Unlike an IRA RMD, the RMDs must be calculated separately for each plan and withdrawn from each plan – an aggregated withdrawal is not allowed.
How do the RMD rules apply to Inherited IRAs?
When a surviving spouse inherits an IRA, the spouse has the following options if the decedent
dies after taking RMDs: 1) treat the IRA as his/ her own, 2) take RMDs based on his/her current
age, or 3) base the RMDs on the decedent’s age at death. If the decedent died before beginning RMDs, the surviving spouse can 1) treat the IRA as his/ her own, 2) withdraw the entire balance by the end of the 5th year following the decedent’s death or 3) wait until the decedent would have turned 70 ½ before taking RMDs, basing the table amounts on his/her current age.
In contrast, if an individual other than a surviving spouse inherits an IRA, the beneficiary has the following options: 1) withdraw the entire balance by the end of the 5th year following the decedent’s death if the decedent died before beginning RMDs or 2) calculate the RMDs. The RMDs vary depending on whether the decedent died before or after RMDs. If the decedent was taking RMDs at the time of death, then the beneficiary would take RMDs based on the longer of the individual’s remaining life expectancy determined in the year following the death or the decedent’s remaining life expectancy at the time of death, reduced by one for each following year. If the decedent died before taking RMDs, then the RMD would be based on the beneficiary’s age at year-end following the year of the decedent’s death, reduced by one for each following year.
What happens if the RMD is missed and not taken?
If the distributions are less than the RMD for a particular year, then a tax of 50% of the undistributed RMD applies for that tax year. However, in Part IX of Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, a waiver of the additional tax can be requested by explaining why the RMD was missed, the amount that should have been taken, and the actions taken to correct the situation. A “RC” code (for “reasonable cause”) should be listed on Form line 54, along with the amount requested for the waiver as a negative number, with a 0 listed in box 54.