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Nov 15, 2019

Everything You Need to Know About Required Minimum Distributions (RMDs)

It’s an important time of year to understand upcoming actions you need to take with your IRA accounts. 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.


What is a Required Minimum Distribution?

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 70½. 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.


When must I begin taking RMDs out of my traditional IRA?

You must begin taking a minimum payment from your traditional IRA each year starting with the year you attain age 70½. You will reach age 70½ exactly six months following your 70th birthday. If you turn age 70 during the first six months of the year, you will be 70½ in that same calendar year and will be required to take an RMD for that year. If your birthday falls in the second half of the year, you will turn 70½ in the next year, so your first RMD will be due in the year you turn 71.

You have until April 1 of the year following the year you attain age 70½ 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 next year (e.g., until 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.  


How much am I required to take as an RMD?

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. 


Can I take my RMD from another account?

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.


Can I take my RMD from my Roth IRA?

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, which generally allow Roth IRA beneficiaries to take distributions under either the five-year rule or the life expectancy rule. 


How will I know how much to take each year?

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.


What if I don't want to liquidate my investment to take 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.


What if I don't take an RMD when it is due?

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.


Are RMDs reported to the IRS?

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.


What happens to my RMDs after I die?

Your RMD due in the year of your death must be taken by your beneficiaries if it had not yet been distributed. In the following year, your IRA beneficiaries will be required to continue taking distributions from the IRA. Their distribution options will vary depending on whether the beneficiary is your spouse, a nonspouse, or a non-individual such as a trust or an estate. The distribution options available to a beneficiary generally determine the minimum payment a beneficiary must take from an IRA. Most IRAs will allow a beneficiary to take payments more rapidly than required under the beneficiary rules.


We can all agree that having the ability to contribute to a qualified retirement plan 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, it’s included the Required Minimum Distribution (RMD) provision 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 70 ½ to plan your RMD strategy.

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