Required Minimum Distributions (RMDs) – Time is Running Out

86528026Key Takeaways

  • What are RMDs?
  • Do they apply to you?
  • How to calculate them. 

If you or a spouse has a 401(k) or an IRA, and turned 70 1/2 in 2014 or earlier, don’t forget about your big deadline looming on December 31. And I’m not talking about New Year’s Eve plans. December 31 is the date by which you must take your annual Required Minimum Distribution (RMD), or face significant penalties. We’re always surprised by how many people forget (or fail) to take these distributions.

What are required minimum distributions (RMDs)?

Your RMDs, are amounts that the federal government requires you to withdraw annually from traditional IRAs, 401(k)s and other employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the required minimum amount from your IRA or other retirement plan in any year–but, if you withdraw less than the required minimum, you will be subject to a stiff federal penalty. More on that in a minute.

The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, RMDs generally have the effect of producing taxable income during your lifetime—something the government likes.

Which retirement savings vehicles are subject to the RMD rules?

In addition to traditional IRAs, simplified employee pension (SEP) IRAs, SIMPLE IRAs and Employer-sponsored retirement plans are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are still alive. Although you are not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will generally be required to take distributions from the Roth IRA after you die. 

When must RMDs be taken?

Your first required distribution from an IRA or retirement plan occurs in the year in which you reach age 70½. However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year.  Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die, or until your balance is reduced to zero. 

How are RMDs calculated?

RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made.

For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your account balance as of December 31 of the prior year by your distribution period that is determined under the Uniform Lifetime Table (see an abbreviated table below) using your attained age in that calendar year. This life expectancy table is based on the assumption that you are unmarried or have a spouse who is less than 10 years younger than you are.  Another table is used if your spouse is more than 10 years younger than you.  Always work with your tax advisor or wealth advisor to determine the appropriate table for you.

If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own IRAs for this purpose. (Similar rules apply to Section 403(b) accounts.) If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan. 

What if you fail to take RMDs as required?

You can always withdraw more than the required minimum from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty—and it’s not a trivial amount. The penalty is a 50 percent excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year. 

Inherited IRAs and retirement plans

Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or beneficiaries) will then typically be required to take minimum required distributions from the account. A spouse beneficiary may generally roll over an inherited IRA or plan account into an IRA in the spouse’s own name, allowing the spouse to delay taking additional required distributions until he or she turns 70½.

Conclusion

In an effort to simplify this blog, we eliminated some details that go beyond this discussion.  RMD planning is complicated and you should consult with your tax professional or wealth advisor before making any decisions.  Contact us any time (610.695.8070)  if you or someone close to you needs help sorting through these complex issues.

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About Mark Rioboli

Mark A. Rioboli, CFP®, CFS is Director of Wealth Management for Independence Advisors, bringing over 25 years of experience in the wealth management industry. Have a question for Mark? CLICK HERE TO ASK MARK

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