For RMDs (Required Minimum Distributions) Timing is Everything

When to begin taking Required Minimum Distributions (RMDs) has become an important issue in recent years, as more people delay retirement and continue to work into their seventies and beyond. These days, people who not too long ago, would have been retired and drawing down their nest eggs, are still bringing home paychecks. They don’t need or want to take distributions from their retirement funds.

Holders of traditional IRAs (as well as SEP and SIMPLE IRAs) typically must begin taking minimum distributions when they reach 70½ years of age (take heed all those who turned 70½ in 2015). Account owners may postpone the initial year’s RMD until April 1 of the following year, but if they do that, they are required to take two distributions in the next year. In each subsequent year, the RMD must be taken by December 31.

Remember that while postponing the initial RMD may have some benefits, taking two in the following tax year may have tax consequences.  I recommend that investors consult their financial advisors and/or tax professionals before deciding.

RMD rules differ for qualified plans, such as  401(k)s. Unlike with a traditional IRA, 401(k) plan participants (who own 5% or less of the business sponsoring the plan) can defer their initial RMD to either the end of the calendar year in which they reach age 70½ or to December 31 of the year in which they retire from the employer maintaining the plan, whichever comes later.

Consider this example, employee John Public, age 74, retires on December 1, 2015. John wants to roll over his 401(k) account to an IRA immediately. But John Public must take a minimum distribution before he rolls the account into an IRA. The 401(k) administrator should be calculating and processing the RMD amount prior to the rollover.

Unfortunately, as I have seen happen too many times, the rollover is completed without the RMD being taken. Unfortunately, the correction isn’t as simple as distributing the equivalent of the missed RMD from the IRA. For one thing, RMDs cannot be rolled over. And the tax rules are clear that distributions from a 401(k) or other qualified plan to an IRA are characterized as rollovers.

To illustrate, when John Public decides to retire, he has $100,000 in his 401(k). He needs to withdraw $5,000 to satisfy his 2015 RMD prior to rolling over the remainder to an IRA. But because the RMD was not fulfilled and, instead, the entire $100,000 was rolled over, John Public’s IRA now has an excess of $5,000.

Undoing this error involves considerable cost, time and paperwork. Investors should work with their IRA custodian to remove the amount of the excess contribution, plus any earnings. Also, the tax reporting must be coded as an excess contribution, rather than an RMD, on IRS Form 1099-R. The excess funds must be withdrawn in a timely manner, or the excess contribution will be subject to a 6% penalty for every year it remains in the IRA.

I can’t stress enough how important it is to be aware of this potential pitfall, which I have been seeing more frequently, as older workers remain on the job longer and take their retirements later.

More RMD Tips

  • If someone owns multiple IRAs, RMDs are calculated separately for each IRA, but the required RMDs can be aggregated and the distribution satisfied from one or more of the owned accounts. Similarly, total RMDs across all 403(b) accounts may be taken from one or multiple 403(b)s. IRA minimum distributions may not be taken from 403(b)s, and 403(b) minimum distributions may not be taken from IRAs.
  • 401(k) plan rules do not allow for aggregation. Instead, RMDs must be calculated on each plan and distributed independently.
  • Lifetime RMDs are generally calculated using the IRS Uniform Life Table, unless the accountholder’s beneficiary is a spouse, the sole beneficiary, and more than 10 years younger than the account owner.
  • Employees aged 70½ or older are eligible to participate in a SEP or SIMPLE-IRA, assuming they satisfy the plan’s eligibility requirements. However, once an employee attains 70½, RMDs are required.
  • The IRS can waive the 50% penalty on missed RMDs for “good cause.”

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