The end of the year marks an important deadline for those who have been accumulating assets in a retirement account. That is because the majority of those who are over the age of 70.5 must take a required minimum distribution (RMD for short) from their retirement accounts before December 31st of each year. However, there are a number of caveats to this requirement, because it wouldn’t be an IRS rule if there weren’t exceptions and exemptions.
WHAT is a Required Minimum Distribution?
Required Minimum Distributions are exactly what they sound like; a minimum amount that must be withdrawn from certain types of retirement accounts each year, as required by the IRS. It is the federal government’s way to make sure they begin receiving tax revenue on the contributions and growth of your retirement accounts that have accumulated tax deferred for all of these years…after all, there are no free lunches when it comes to income taxes!
WHO must take an RMD?
Individual Retirement Account (IRA) owners, including owners of SEP IRAs and SIMPLE IRAs, as well as qualified retirement plan account holders, are required to take RMDs. However, requirements differ with different account types. Below is a list of common accounts that require minimum distributions annually:
- Traditional IRA
- SEP IRA
- SIMPLE IRA
- 401k Plans
- Roth 401k Plans
- 403b Plans
- 457b Plans
- NOTE: RMD rules do not apply to Roth IRAs while the original owner is still alive
WHEN must an RMD be taken?
The initial required minimum distribution for an account owner must be taken by April 1st of the year following the year the account holder reaches age 70.5. After the first year, RMDs are due by 12/31 of each year thereafter. For example, if someone turns 70.5 in March of 2018, he/she will have until April 1st of 2019 to take the 2018 RMD.
If they wait until the following year to take that first RMD, they will then have to take the following year’s RMD by 12/31 as well, making it so that two RMDs were taken in the same year (one by 4/1 and one by 12/31). This could have significant tax implications for those in higher income tax brackets, so even though there is an option of waiting until the year following turning age 70.5, it may not make sense to wait that long. This is a discussion we have with our clients all the time, so consult your advisor or accountant to assess your individual situation.
HOW is the RMD Calculated?
The calculation for the annual RMD is pretty straightforward. Account owners simply take their year end account balance from the previous year, and divide it by an age factor determined by an IRS table. The specific table to be used depends on each account owners circumstances (i.e. original account owner who is married, the age difference between the account owner and their spouse, or if the account was inherited from someone else) so again, reach out to your advisor or accountant for assistance.
WHAT Happens if an RMD is not taken in time?
The penalty for not withdrawing an RMD in time is very steep and is 50% of the amount that was required to be withdrawn. For example, if you were supposed to withdraw $5,000 before year end, but did not do that for some reason, the penalty for not taking the appropriate RMD would be equal to $2,500.
The IRS is usually pretty accommodating for those who have neglected to withdraw timely. In this case, the account owner should complete form 5329 with their annual tax return and withdraw the appropriate RMD as soon as possible. The IRS will inform you if they accept your request for waiver of penalty.
Aggregating Distributions Across Multiple Accounts
If someone owns multiple traditional IRA accounts, the RMD amounts due from each account must be determined at the individual account level, but the total distribution can be aggregated and withdrawn from one single IRA account. As long as the total amount withdrawn from the single IRA equals the amount that was due to be taken across all of the IRA accounts, the IRS allows this as an option. This provides for a tremendous planning opportunity for those with well diversified portfolios as account owners can be strategic about which assets they sell and withdraw depending on the investment performance for the year.
This same flexibility does not apply to other retirement plans, such as 401k accounts. RMDs must be taken from other retirement accounts at the individual account level and cannot be aggregated and withdrawn from one account.
The “Still Employed” Exemption
There is one other exemption worth noting about RMDs. If you are over 70.5 but are still employed with the company your 401k account is with, you DO NOT have to take your RMD from that account while you are still employed.
An exception to the “still employed” rule applies to the owners of businesses. A 5% owner of the business sponsoring the retirement plan, must still take their RMD for the year if over age 70.5, regardless of whether or not they have retired.
Matt Crisafulli, EA, CFP® is a Partner at ACap Advisors & Accountants, as well as a UCLA Alumnus. He is a Fee-Only CERTIFIED FINANCIAL PLANNER™ practitioner and an Enrolled Agent licensed by the IRS.
ACap Advisors & Accountants is a “Fee-Only” wealth management and full-service accounting firm headquartered in Los Angeles, specializing in helping doctors and healthcare professionals make sound financial decisions.
Contact ACap at info@acapam.com or 818-272-8511.
