RMD Rules for IRAs and Employer Plans | Rodgers & Associates

A Guide to Required Minimum Distribution Rules for IRAs and Employer Plans

Seniors reaching the age of 73 will soon learn the downside of using a tax-deferred account for saving. The funds they have set aside to grow without being taxed are going to start gener­ating tax conse­quences. Required minimum distri­b­u­tions (RMDs) are about to begin for IRAs and for employer retirement plans, such as 401(k)s and 403(b)s. RMD rules are similar for both types of accounts, but there are some differences.

Let’s start by reviewing the basics. A person turning age 73 must take their first RMD by April 1st of the year following the year they turn age 73. The RMD is due by December 31st of each year there­after. RMDs from company sponsored retirement plans and IRAs are calcu­lated in the same manner.

The amount of the RMD is calcu­lated by taking the account balance on December 31st of the prior year and dividing it by the life expectancy of the account owner. Life expectancy can be found in the IRS’s Uniform Lifetime Table. If the taxpayer’s spouse is the sole benefi­ciary and is more than 10 years younger, than they will use the Joint Life and Last Survivor Expectancy Table. The taxpayer will use the age attained during the year they reached age 73. Even if they wait until April 1st of the following year the calcu­lation is based on their age in the prior year.

RMDs from IRA Accounts vs. Employer Retirement Plans

These are some of the key differ­ences of RMD rules as they pertain to an IRA versus an employer sponsored retirement plan.

When RMDs are Processed

One important difference between IRAs and company plans is that many plans process all RMDs around the beginning of December, including any initial year RMDs. Plan partic­i­pants won’t have the option to delay their initial year RMD until April 1st of the next year, unless the plan agrees. You should check with your company plan admin­is­trator to determine what the plan allows.

Multiple IRA accounts can be aggre­gated to calculate the RMD and the withdrawal will only need to be taken from one of the accounts. Tradi­tional IRAs, SEP IRAs, SIMPLE IRAs can all be handled this way. An inherited IRA cannot. The inherited IRA must satisfy the RMD separately. Roth IRAs are not subject to RMDs and should not be included in the total. Employer plans are subject to their own RMD and it cannot be satisfied by taking the amount from an IRA.

“Still Working” Provision

A second important difference between IRAs and employer sponsored retirement plans is that plan partic­i­pants who are still working get a pass at age 73 if they don’t own more than 5% of the company. This is called the “still working” exception. The due date for their first RMD from their company plan after they have reached age 73 will be April 1st of the year after they separate from service.

There is no minimum number of hours needed to be considered “still working.” An employee of a company could transition from a full-time employee to part-time and still qualify for the exception. The “still working” exception is optional for employer plans. However, most plans have adopted the provision, and the tax code makes the “still working” exception the default rule if the plan document is silent.

This exception only applies to the plan sponsored by the individual’s current employer. Taxpayers with more than one employer plan will have to calculate the RMD for each plan and take the withdrawal from the plan. The exception to this rule occurs when a taxpayer has more than one 403(b) account. The account owner can aggregate all their 403(b) account balances and take the RMD from just one of the accounts.

There is an additional exception for taxpayers who partic­i­pated in a 403(b) plan before 1987. For these plans, the RMDs for contri­bu­tions made before 1987 do not have to be taken until age 75. If the partic­ipant is still working at age 75, RMDs from “pre-1987 amounts” can be delayed until retirement. Taxpayers should have a statement showing the plan balance on December 31, 1986 as documen­tation to prove the exemption. Any funds contributed on or after January 1, 1987, and the earnings on the pre-1987 balance is subject to the age 73 due date making this a compli­cated calcu­lation to track.

Inherited IRA RMD Rules for Beneficiaries

RMDs from inherited tradi­tional IRAs and inherited Roth IRAs have a different set of rules. The first RMD must generally be taken by December 31st of the year after the year of the original owner’s death and be taken by the end of each future year. There are special excep­tions for spouses who inherit. The amount of the RMD will be based on the age of the oldest benefi­ciary when there are multiple benefi­ciaries unless the inherited IRA is split by the end of the year of death. Splitting the IRA into separate properly titled inherited IRAs allows each benefi­ciary to take advantage of distri­b­u­tions based on their own life expectancy.

RMDs from the account of a deceased IRA owner who was past age 73 must be taken by year end by the benefi­ciary. The benefi­ciary takes the year-of-death RMD and reports the income on his or her tax return. It does not go on the decedent’s final income tax return or on his or her estate income tax return. The year-of-death RMD is based on the amount the decedent would have had to take had he or she lived. The following year, the benefi­ciary calcu­lates the amount based on the longer of his own life expectancy or the deceased owner’s remaining life expectancy. For some benefi­ciaries, the inherited account must also be emptied by the end of the 10th year following the year the original owner passed away.That’s basically all there is to it. Calculate the right amount and withdraw it by the due date. However, if you miss the due date or don’t take out enough, there is a 25% tax penalty for any shortfall.

Rick’s Insights:

  • RMD rules are similar for IRAs and employer sponsored retirement plans but there are some differences.
  • A person turning age 73 must take their first RMD by April 1st of the year following the year they turn age 73.
  • The “still working” exception delays the first RMD from a company plan where the employee is still working until April 1st of the year after they separate from service.

Origi­nally posted November 2018