Note: This blog has been updated on 3/20/2020 to reflect the most recent changes made by the SECURE Act.
It’s important to understand how the recent law changes affect your IRA. One of the more relevant topics IRA owners should be aware of is a Required Minimum Distribution (RMD). Below are some of the most common questions that Mainstar receives.
Individuals who save in a tax-qualified retirement account are required to begin withdrawing a minimum amount each year from their retirement accounts when they reach age 72.* These plans hold primarily pre-tax contributions with tax-deferred investment earnings, so the Required Minimum Distribution (RMD) rules ensure these tax-sheltered savings ultimately become taxable. These rules apply to employer sponsored plans, like 401(k) and 403(b) plans, traditional IRAs (including those holding SEP plan contributions), and SIMPLE IRAs. Roth IRAs are not subject to the RMD rules while the IRA owner is alive, but Roth IRA beneficiaries are required to take distributions after the IRA owner’s death.
* The SECURE Act of 2019 increased the RMD starting age from 70½ to 72. Individuals who reached age 70½ by December 31, 2019, had to begin RMDs at age 70½. An individual reaches age 70½ exactly six months following their 70th birthday. If you were not age 70 by June 30, 2019, you would not have reached age 70½ by the end of 2019 and may begin taking RMDs at age 72.
You must begin taking a minimum payment from your traditional IRA each year starting with the year you attain age 72. You have until April 1 of the year following the year you attain age 72 to take your first distribution. This is referred to as your required beginning date. You must continue taking distributions by December 31 each year thereafter. If you wait to take your first RMD until the year after you turn 72 (by your April 1 required beginning date), you will be required to take two RMDs that year, resulting in two taxable distributions in the same calendar year.
RMDs must be calculated following the rules in the tax laws. The annual RMD calculation will determine the minimum amount that must be distributed for the year, but you may always take more.
The RMD amount is calculated by taking your IRA’s December 31 balance from the prior year and dividing it by a life expectancy factor. The life expectancy factor is generally based on your life expectancy, but if your spouse is your sole IRA beneficiary and is more than 10 years younger than you, your RMD may be based on the joint life expectancy of you and your spouse. This calculation will result in a lower RMD than a calculation using only your life expectancy. You can find the life expectancy tables used for these calculations in IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).
Your RMD may be satisfied with a single payment or in multiple payments throughout the year.
If you have more than one IRA, a separate calculation must be completed to determine the RMD for each specific IRA, but you may then take the aggregated RMD amount from just one IRA, split the RMDs among the IRAs, or take the specific RMD amount from each IRA. The types of IRAs that may be aggregated for RMD purposes are traditional IRAs, SEP IRAs, and SIMPLE IRAs. This allows you to choose which investments to liquidate across your IRAs.
RMDs may not be satisfied by a Roth IRA distribution. Roth IRAs are not subject to the RMD rules while the IRA owner is alive. This allows retirement savings to continue to grow each year, yet the assets remain accessible if needed. After the IRA owner’s death, the Roth IRA beneficiaries will be required to follow the RMD requirements for beneficiaries.
If you are an accountholder with Mainstar we will notify you each year by January 31 if you are required to take an RMD for the year. We will calculate the RMD based on your life expectancy, unless you notify us to incorporate the age of your spouse if he or she is more than 10 years younger than you.
Because you may transfer your IRA balances, including RMD amounts, among your IRAs or take your RMD from another IRA without notifying us, we will wait for your payment instructions before paying out an RMD.
If you do not wish to liquidate an alternative investment to satisfy an RMD, and there is not enough cash in your other IRAs to distribute the RMD amount, you may choose to take an in-kind distribution from your IRA. If you choose an in-kind RMD, Mainstar as your custodian would re-register the alternative asset into your name or into the name of the custodian holding a taxable account on your behalf. RMDs cannot be rolled over to another tax-qualified account.
Is my RMD taxable?
RMDs may be fully or partially taxable, depending on the types of contributions made to the IRA. If your traditional IRA holds nondeductible or after-tax rollover dollars from an employer plan, a portion of your RMDs may not be taxable. You are required to track your nondeductible contributions using IRS Form 8606, Nondeductible IRAs, which should be attached to your Form 1040.
Since RMDs are required by tax law, there is a penalty for failing to comply with the RMD requirements. A 50% excess accumulation excise tax applies to the taxable portion of the RMD amount that should have been distributed but was not (or the difference between the required amount and any lesser amount actually withdrawn). This tax is in addition to your regular income tax that you will owe for the distribution. For example, if an IRA owner had a $5,000 RMD due for a year and failed to distribute anything that year, the penalty would be $2,500—50% times the $5,000 missed RMD. IRA owners must report and remit the 50% tax to the IRS using Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts. Form 5329 is filed with your tax return for the year.
RMDs are reported to the IRS. IRA custodians must indicate on Form 5498, IRA Contribution Information, if an RMD is due for the year from that account and file Forms 5498 with the IRS by May 31 each year. Any RMD distributed from your IRA must be reported on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. You must also report your RMD on Form 1040, your federal income tax return.
When you die, your IRA beneficiaries must take any remaining RMD due for the year. In the following year, your beneficiaries will be required to follow the beneficiary distribution rules. Their distribution options will vary depending on whether each beneficiary is an “eligible designated beneficiary” as defined by the SECURE Act of 2019 (i.e., a surviving spouse, disabled individual, chronically ill individual, minor child of the IRA owner until the age of majority, or nonspouse beneficiary who is less than 10 years younger than the IRA owner). Eligible designated beneficiaries have distribution options available to them such as taking annual payments over their life expectancy. Other beneficiaries generally must deplete the inherited IRA within 10 years following the year of death.
We can all agree that having the ability to contribute to a retirement savings account that reduces our current tax liability while allowing our money to grow tax deferred is a tremendous benefit. But, as the term “tax deferred” implies, the government intends to collect taxes on your retirement money at some point. To ensure that taxes can’t be deferred forever, the government has included the Required Minimum Distribution (RMD) provisions in the tax code.
The RMD rule seems reasonable enough on its face, except that it includes a penalty if it’s not followed to the letter. Not understanding the RMD rule, especially as it applies to your long-term income needs, can prove very costly, which is why it’s important to incorporate it into your retirement income planning. The biggest takeaway from this all? Don’t wait until age 72 to plan your RMD strategy.