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

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Seniors reaching the age of 70 ½ 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 70 ½ must take their first RMD by April 1st of the year following the year they turn age 70 ½. 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 70 ½. Even if they wait until April 1st of the following year the calculation is based on their age in the prior year. For example, a taxpayer turns 70 ½ in the first half of the year, they will be 71 before the end of the year. In this example they would use age 71, even if they waited until March 31st of the next year to calculate the RMD.

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 70 ½ 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 70 ½ 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 70 ½ 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 the stretch IRA based on their own life expectancy.

RMDs from the account of a deceased IRA owner who was past age 70 ½ 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.

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 50% tax penalty for any shortfall.

Rick’s Tips:

  • RMD rules are similar for IRAs and employer sponsored retirement plans but there are some differences.
  • A person turning age 70 ½ must take their first RMD by April 1st of the year following the year they turn age 70 ½.
  • 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.

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