What is a Required Minimum Distribution?

wealth-1What are required minimum distributions (RMDs)?

Required minimum distributions, often referred to as RMDs, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty.

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, required minimum distributions generally have the effect of producing taxable income during your lifetime.

Which retirement savings vehicles are subject to the RMD rules?

In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are 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 your death.

Employer-sponsored retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your employer-sponsored plan, you should consult your tax professional.

When must RMDs be taken?

Your first required distribution from an IRA or retirement plan is for the year 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 your balance is reduced to zero.

There is one situation in which your required beginning date can be later than described above. If you continue working past age 70½ and are still participating in your employer’s retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own five percent or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.

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.

Example(s):         You have a traditional IRA. Your 70th birthday is November 1, 2013, and you therefore reach age 70½ in 2014. Because you turn 70½ 2014, you must take an RMD for 2014 from your IRA. This distribution (your first RMD) must be taken no later than April 1 of 2015. In calculating this RMD, you must use the total value of your IRA as of December 31, 2013.

Caution:   When calculating the RMD amount for 2014, you base the calculation on the IRA or plan balance as of December 31, 2013, regardless of whether or not you waited until April 1 of the following year to take your first required distribution.

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, determined under the Uniform Lifetime Table using your attained age in that calendar year.

One exception to the procedure described above is when the sole designated beneficiary is your spouse, and he or she is more than 10 years younger than you, the calculation of your RMDs may be based on a different table. (These life expectancy factors can be found in IRS Publication 590.)

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 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 you are required to 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. 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.

About Barbara Richardson

As Director of Client Services, Barb leads the effort to improve the Independence Advisors client experience, taking advantage of insights from more than 22 years experience in financial services.

, , , , ,