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Required Minimum Distributions

Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 72 (age 70½ if reached before January 1, 2020), or, in some cases, after you retire. You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty.

The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime. 

 

Which Retirement Ravings Vehicles are Subject to the RMD Rules?

In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive. Although you are not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will generally be required to take distributions from the Roth IRA after your death. 

Employer-sponsored retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your employer-sponsored plan, you should consult your plan administrator or a tax professional. 

When Must RMDs be Taken?

Your first required distribution from an IRA or retirement plan is for the year you reach age 72 (age 70½ if reached before January 1, 2020). However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 72, or you can delay it until April 1 of the following year. 

Since this first distribution generally must be taken no later than April 1 following the year you reach age 72, this April 1 date is known as your required beginning date. Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year — your first year’s required distribution and your second year’s required distribution. 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019 raised the RMD age from 70½ to 72, effective January 1, 2020. In addition, the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed in March 2020 waived RMDs for 2020, including any for those who turned 70½ in 2019 but opted to delay their first RMD until April 1, 2020. The combined effects of these Acts mean that if you reach age 72 before July 1, 2021 (and therefore reached age 70½ before 2020), you will need to take your 2021 RMD by December 31, 2021. 

You have a traditional IRA. Your 72nd birthday is December 2, 2021. You can take your first RMD during 2021, or you can delay it until April 1, 2022. If you choose to delay your first distribution until 2022, you will have to take two required distributions during 2022 — one for 2021 and one for 2022. This is because your required distribution for 2022 cannot be delayed until the following year. 

There is one situation in which your required beginning date can be later than described above. If you continue working past age 72 (70½ if reached before January 1, 2020) and are still participating in your employer’s retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own 5% or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year. 

You own more than 5% of your employer’s company and you are still working at the company. Your 72nd birthday is on December 2, 2021. You must take your first RMD from your current employer’s plan by April 1, 2022 — even if you’re still working for the company at that time. 

You participate in two plans — one with your current employer and one with your former employer. You own less than 5% of each company. Your 72nd birthday is on December 2, 2021, but you’ll keep working until you turn 73 on December 2, 2022. You can delay your first RMD from your current employer’s plan until April 1, 2023 — the April 1 following the calendar year in which you retire. However, as to your former employer’s plan, you must take your first distribution (for 2021) no later than April 1, 2022 — the April 1 after reaching age 72. 

How Are RMDs Calculated?

RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made. 

You have a traditional IRA. Your 72nd birthday is November 1, 2021, so you must take an RMD for 2021. This distribution (your first RMD) must be taken no later than April 1, 2022. In calculating this RMD, you must use the total value of your IRA as of December 31, 2020. 

When calculating the RMD amount for your second distribution year, you base the calculation on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age 72) regardless of whether or not you waited until April 1 of the following year to take your first required distribution. 

For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your account balance as of December 31 of the prior year by your distribution period, determined under the Uniform Lifetime Table using your attained age in that calendar year. This life expectancy table is based on the assumption that you have designated a beneficiary who is exactly 10 years younger than you are. Every IRA owner’s and plan participant’s calculation is based on the same assumption. 

There is one exception to the procedure described above. If your sole designated beneficiary is your spouse, and he or she is more than 10 years younger than you, the calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your spouse. (These life expectancy factors can be found in IRS Publication 590.) Consequently, if your spouse is your designated beneficiary and is more than 10 years younger than you, you can take your RMDs over a longer payout period than under the Uniform Lifetime Table. If your beneficiary is a non-spouse or a spouse who is not more than 10 years younger than you, you are subject to the shorter payout period under the simplified general rule. 

In order for the younger spouse rule to apply, your spouse must be your sole beneficiary for the entire distribution year. The final regulations specify that your spouse will be considered your sole beneficiary for the entire year if he or she is your sole beneficiary on January 1 of the year, and you do not change your beneficiary during the year. In other words, even if your spouse dies, or you get divorced after January 1, you can use the younger spouse rule for that distribution year (but not for distribution years that follow). In the case of divorce, however, if you designate a new beneficiary prior to the end of the distribution year, you cannot use the younger spouse rule (since your former spouse will not be considered your sole beneficiary for the entire year). 

If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. [Similar rules apply to Section 403(b) accounts.] If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan. 

Should You Delay Your First RMD?

RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made. 

You have a traditional IRA. Your 72nd birthday is November 1, 2021, so you must take an RMD for 2021. This distribution (your first RMD) must be taken no later than April 1, 2022. In calculating this RMD, you must use the total value of your IRA as of December 31, 2020. 

When calculating the RMD amount for your second distribution year, you base the calculation on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age 72) regardless of whether or not you waited until April 1 of the following year to take your first required distribution. 

For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your account balance as of December 31 of the prior year by your distribution period, determined under the Uniform Lifetime Table using your attained age in that calendar year. This life expectancy table is based on the assumption that you have designated a beneficiary who is exactly 10 years younger than you are. Every IRA owner’s and plan participant’s calculation is based on the same assumption. 

There is one exception to the procedure described above. If your sole designated beneficiary is your spouse, and he or she is more than 10 years younger than you, the calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your spouse. (These life expectancy factors can be found in IRS Publication 590.) Consequently, if your spouse is your designated beneficiary and is more than 10 years younger than you, you can take your RMDs over a longer payout period than under the Uniform Lifetime Table. If your beneficiary is a non-spouse or a spouse who is not more than 10 years younger than you, you are subject to the shorter payout period under the simplified general rule. 

In order for the younger spouse rule to apply, your spouse must be your sole beneficiary for the entire distribution year. The final regulations specify that your spouse will be considered your sole beneficiary for the entire year if he or she is your sole beneficiary on January 1 of the year, and you do not change your beneficiary during the year. In other words, even if your spouse dies, or you get divorced after January 1, you can use the younger spouse rule for that distribution year (but not for distribution years that follow). In the case of divorce, however, if you designate a new beneficiary prior to the end of the distribution year, you cannot use the younger spouse rule (since your former spouse will not be considered your sole beneficiary for the entire year). 

If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. [Similar rules apply to Section 403(b) accounts.] If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan. 

What If You Fail To Take RMDs As Required?

You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 50% excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year. 

You own one traditional IRA and compute your RMD for year one to be $7,000. You take only $2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at least $7,000 as a distribution but have only taken $2,000, your RMD exceeds the amount of your actual distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50% of $5,000). 

You report and pay the 50% tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to “reasonable error” and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return, and attach a letter of explanation. The IRS will review the information you provide and decide whether to grant your request for a waiver. 

Can You Satisfy the RMD Rules With a Purchase of an Annuity Contract?

Your purchase of an annuity contract with the funds in your IRA or retirement plan satisfies the RMD rules if all of the following are true: 

  • Payments are made at least yearly 
  • The annuity is purchased on or before the date that distributions are required to begin 
  • The annuity is calculated and paid over a time period that does not exceed those permitted under the RMD rules 
  • Payments, with certain exceptions, are non-increasing 

You may also be able to use up to 25% of your non-Roth IRA and retirement plan account balances (up to a maximum of $135,000 from all accounts, indexed for inflation) to purchase a qualifying longevity annuity contract (or QLAC). The value of the QLAC is disregarded when you calculate the amount of RMDs you are otherwise required to take from your account each year. Payments from the QLAC can be delayed up to age 85, and are treated as satisfying the RMD rules when paid. The rules can be complicated, and QLACs are not right for everyone, so be sure to consult a qualified professional for further information. (Note: Any annuity guarantees are subject to the claims-paying ability and financial strength of the annuity issuer.) 

Tax Considerations

Income tax 

Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan. 

For example, if some of your traditional IRA contributions were not tax deductible, those contribution amounts will be income tax free when you withdraw them from the IRA. This is simply because those dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any after-tax contributions. [Special tax rules apply to Roth IRAs and Roth 401(k)/403(b) contributions.]

Taxable income from an IRA or retirement plan is taxed at ordinary income tax rates even if the funds represent long-term capital gains or qualifying dividends from stock held within the plan. There are special rules for capital gains treatment in some cases on distributions from retirement plans. 

Gift and estate tax 

You first need to determine whether or not the federal gift and estate tax will apply to you. If you do not expect the value of your taxable estate to exceed the applicable exclusion amount, then federal gift and estate tax may not be a concern for you. However, state death (or inheritance) tax may be a concern. In some cases, your assets may be subject to more than one type of transfer tax — for example, the generation-skipping transfer tax may also apply. Consider getting professional advice to establish appropriate strategies to minimize your future gift and estate tax liability. 

For example, you might reduce the value of your estate by gifting all or part of your required distribution to your spouse or others. Making gifts to your spouse can sometimes work well if your estate is larger than your spouse’s, and one or both of you will leave an estate larger than the applicable exclusion amount. This strategy can provide your spouse with additional assets to better utilize his or her applicable exclusion amount, thereby minimizing the combined gift and estate tax liabilities of you and your spouse. Be sure to consult an estate planning attorney, however, about this and other possible strategies. 

In addition to federal gift and estate tax, your state may impose its own estate or death tax (or other transfer taxes). Consult an estate planning attorney for details. 

Inherited IRAs and Retirement Plans

Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or beneficiaries) will then typically be required to take distributions from the account. A spouse beneficiary may generally rollover an inherited IRA or plan account into an IRA in the spouse’s own name, allowing the spouse to delay taking additional required distributions until he or she turns age 72. Rules for non-spouse beneficiaries depend on whether the beneficiary is an individual (versus a trust or estate), as well as the age and relationship of the individual to the beneficiary. For details, see IRS Publication 590-B. 

As with required lifetime distributions, proper planning for required post-death distributions is essential. You should consult an estate planning attorney and/or a tax professional.

© Broadridge, Inc. – article posted with permission.

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