Understanding the Rules of Required Minimum Distributions (RMDs)

Posted in: Personal Financial Management

A Required Minimum Distribution (RMD) is defined as how long you, as the taxpayer (and after your death, the beneficiary), may defer withdrawals from your retirement account. When it comes to Required Minimum Distributions (RMDs) there are many, many rules and you soon realize that the more you know about RMDs, the more you find out you don’t know. I’m going to walk through some of the key rules to be aware of with two goals in mind – keep your retirement account a tax deferred account for as long as possible, and make sure you are planning your beneficiaries wisely.

When must I start making withdrawals from my retirement account?

By April 1 of the year after you turn 70 ½, you must begin making withdrawals from your retirement account. This date is called the required beginning date (RBD). The IRS sets the RMD amount for each year by dividing the retirement account balance as of the close of business on December 31st of the preceding year by the applicable distribution period or life expectancy. Click here to view IRS tables showing distribution periods and life expectancies.

Are there any exceptions to this rule?

The only exception is if you have an employer sponsored retirement plan and are still working for that employer. You can defer the RMD beginning date until you stop working for that employer. However, you still need to take the RMD from any previous employer plans and IRA accounts.

Also important to note, if you are a five percent owner of the employer, you must start receiving your distribution no later than April 1 of the calendar year following the calendar year you turn 70½.  Once you start receiving your minimum required distribution, you should receive it at least annually and you should complete the appropriate documentation each year until all assets in your account are distributed.

What is the penalty if I miss the RMD deadline?

The RMD must be taken out in order to avoid a 50% penalty on the amount that should have been removed by December 31st.

Following the April 1st RBD, how often must I take my RMD?

You must take your RMD every year by December 31st.

Beneficiary Planning Related to RMDs

In my last post, “Why You Need to Make Beneficiary Planning a Priority,” I talked about the importance of beneficiary planning and those reasons come into play with RMDs.

What are the rules for a spouse beneficiary?

A surviving spouse has the most favorable options – such as being able to roll over the retirement account into his or her own IRA and defer withdrawals from the account until the spouse turns 70 ½. A spouse can then name new beneficiaries. Upon the spouse’s death, the new beneficiaries can use their own life expectancy to stretch out distributions.

What are the rules for a non-spouse beneficiary?

A lot depends on whether a non-spouse beneficiary is a Designated Beneficiary. The IRS generally defines a Designated Beneficiary as an individual or a certain qualified trust that will be allowed stretch out options for their distributions. Estates, charities, and business entities are NOT Designated Beneficiaries.

Non-spouse beneficiaries who are individuals cannot roll the retirement account into their own IRA. Rather, they must set-up an Inherited IRA and begin withdrawals one year after the account owner’s death based on their life expectancy from the appropriate IRS table. It also depends upon whether the retirement account owner died before or after their required beginning date (RBD). If the account owner died before their RBD, the beneficiary’s RMD is based on the beneficiary’s life expectancy. If the account owner died after their RBD, then the beneficiary’s RMD is based on an IRS table that takes into account the longer of the beneficiary’s life expectancy or the account owner’s life expectancy. When the beneficiary dies, the RMD continues to be based on the deceased beneficiary’s life expectancy.

Make sure to check your employer-sponsored retirement plan such as a 401(k) to see if they allow for the ability of a non-spouse beneficiary to stretch out distributions. Typically a company will require a lump sum distribution upon your death so it is something to be aware of in the planning process.

The Designated Beneficiary can withdraw more than the RMD each year, but the RMD (as determined by the IRS RMD table and previous year end retirement account balance) must be taken out in order to avoid a 50% penalty on the amount that should have been removed.  This is the same penalty that applies to the retirement plan account owner that doesn’t meet their RMD by year end.

When it comes to your retirement money, it is more about what you keep.

I recommend clients keeping as much in their retirement accounts as possible. You obviously want to ensure you have enough to live and enjoy your retirement, but the longer you can maintain your retirement account, the more money you will be able to accumulate in this tax deferred account.

With December 31st just around the corner, now is the time you want to talk with your financial advisor. If you have questions or would like further assistance navigating the many rules of RMDs, please contact me at julief@psafinancial.com.

As tax laws may change, please see your financial advisor or tax accounting professional to determine the best strategies for your individual situation.  Investment Advisory Services offered through PSA Financial Advisors, Inc, a Registered Investment Advisor.  Securities offered through PSA Equities, Inc, a registered Broker/Dealer, Member FINRA/SPIC. blog1211261-1dmt