Required Minimum Distributions or RMD’s and what you need to know. The RMD’s are extremely important to people who have reached age 70 and ½ due to their complexity and tax consequences. And yes the stakes are high for someone who does not take their full RMD when required. SO what are the stakes? The IRS will take any portion of the RMD that does not fulfill the entire RMD at 50%. That is a large chunk of money that need to be in your pocket and not the IRS’s.
So what is an RMD? That is the annual withdrawal that people are forced to take from tax-deferred accounts like IRA’s when they do indeed reach age 70 and ½. Funds in these accounts have had the privilege of growing tax-free, and now the IRS and the government want their money. But IRA’s are not the only accounts that this applies to as it also applies to 401(k) and 403(b) accounts. The following is a summary of the IRS rules on RMD’s and some ideas on how to approach them.
If you were to turn 70 and ½ between January 1 and June 30, your first RMD would be no later than April 1 of the following year. No, because you waited until that calendar year you will also be forced to take a second RMD before December 31. That means you will have two RMD’s in the same year creating two taxable events.
Now if you were born between July 1 and December 31 your RMD is not until April 1 of the second following year. And then like the first scenario you would be required to take an additional RMD by December 31, and again you will face two taxable events in the same year.
So how is the RMD calculated? Well, that answer is simple, and they come straight from the IRS tables or Table III of Appendix B, IRS Publication 590-B. So using the tables for an owner and a 10-year younger beneficiary, regardless of the actual age of the beneficiary. However, if the sole beneficiary is indeed the owner’s spouse and is more than ten years younger than the owner, to calculate the RMD, you must use Table II of Appendix B. By doing this you will use the actual joint life expediency of the owner and the spouse.
Each year the RMD is calculated using the IRS account balance from the prior year’s December 31st balance. You take that number and divide it by the appropriate factor from the IRS table. This also includes the year of someone calendar death, meaning if the owner did not take their full RMB at the time of their death the beneficiaries are responsible to withdrawal the remaining portion of the RMD. Under this situation it can create real problems for individuals who pass late in the year and the family is not thinking of RMD’s in these moments as a rule. This is where it is important to have a good tax planner or financial planner working with you on these matters.
So, to determine your RMD go to Appendix A of Publication 590-B. Here is an example of what to do for someone with a balance of $250,000 as of December 31st and they turn 70 in February of the following year. For 2017 the divisor is 27.4 meaning you will divide $250,000 by 27.4 to get an RMD of 9,124.09. Then in 2018, the divisor will change to 26.5, and it will go down a little every year until in theory the account is depleted.
If the owner dies before the RMD age and the beneficiary is something other than an individual such as a charity or their estate the beneficiary entity must take the entire distribution by December 31st of the fifth calendar year after the owner’s death. There are no annual requirements, but the entire amount must be withdrawn by the end of the five-year period.
If the beneficiary is an individual, they may follow the five-year rule, or they could elect to start annual distributions following the year of the owner’s death based on the life expectancy of the new beneficiary. This is calculated using Appendix B, Table I of the IRS publication. If there are multiple beneficiaries, the life expediency of the oldest is used unless the account has been split into separate accounts for each beneficiary.
If the beneficiary is a spouse, the rules are a little different. In addition to the options listed previously, they may also delay them until the deceased would have reached age 70 and ½ and then take the RMD’s based on the spouse’s remaining single life expediency. But the most popular way to handle a spousal account is for the spouse to roll the account over into their IRA and then follow the rules for an individual’s account.
In the event, the owner was past the RMD age the rules get a little simpler in nature. In the event, the beneficiary is a sole owner who is not a spouse they must commence distributions the following calendar year based on the single life expectancy of that beneficiary or the owner’s life expectancy if longer. If the beneficiary is an entity, the owner’s life expectancy is still used to determine the entity’s RMD. For multiple beneficiaries and spouses, the rules are generally the same as noted above. Regardless of what the RMD is an owner or beneficiary is also able to take out more than the RMD but they will be responsible for the tax event it can create.
In the event the owner had a ROTH IRA there are no RMD’s required for them. But beneficiaries are required to make RMD’s in the general terms of a Traditional IRA. But the withdraws of a ROTH IRA are generally non-taxable events.
When IRA’s are combined the owner may take RMD’s from the aggregate account balances from one or more of the IRA’s. The beneficiary of an IRA may only aggregate IRA’s that are the same in nature, Traditional or ROTH from the same previous owner. For qualified plans, the rules outlined above are generally the same except the aggregate opportunities and not applicable to 401(k) plans.
A few techniques to inheriting IRA accounts. If a spouse is younger than 59 and ½, it may make more sense to keep the account as an inherited IRA so they may access the funds penalty free. Then once they turn 59 and ½, convert it into their own IRA. If there are multiple beneficiaries, it is wise to divide the IRA as soon as practicable.