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‘Tis the Season for Required Minimum Distributions (RMDs)

My Financial Coach > Know-More Blog > ‘Tis the Season for Required Minimum Distributions (RMDs)

‘Tis the Season for Required Minimum Distributions (RMDs)

It’s that time of year again, where depending on where you live, might mean freshly fallen snow, and frigid air. However, these conditions are made all the more tolerable with the trappings of the season such as the warmth of crackling wood in the fireplace and a mug of hot cocoa. Regardless of where you live, it is also the season for Required Minimum Distributions (RMDs). 

While a congressionally mandated requirement might not exactly invoke the holiday spirit, in this season of giving, it is also important to understand the rules of taking…your RMD that is. Even if you are not required to take an RMD this year, it is important to understand what RMDs are, who they apply to, when must they be taken, how they are calculated, what special provisions they have, and finally what the future holds for the rules surrounding them.

What are RMDs?

Today, a majority of working individuals will find themselves contributing to either one or different types of retirement accounts. While the premise of contributing to these accounts is to save on paying taxes and grow the accounts, you are not allowed to hold off not paying taxes from these accounts indefinitely. 

Thus, just as Congress has passed laws penalizing individuals from withdrawing funds too early from a retirement account (often 59 ½ for IRAs, and sometimes as young as 55 in employer plans), there are laws that require distributions be taken starting at age 70 ½. In fact, failing to satisfy these distributions may result in a 50% tax penalty on the distribution!

It is important to note that RMDs are also required of those who inherit retirement assets which we will discuss more in the “Who” and “What” sections of this article.

Who do RMDs apply to? 

RMDs apply to all owners of retirement accounts such as IRAs (including SEP and SIMPLE) and 401(k), 403(b), profit-sharing, and other defined contribution plans. One exception is for Roth IRAs, however, Roth 401(k) and Roth 403(b) owners are subject to the same RMD rules even though the distributions are not taxed. For IRA owners, regardless if you continue to work after the age of 70 1/2, you will need to take RMDs. However, those in other employer plans may be allowed to postpone distributions until the year of their retirement (unless they are more than 5% owners). 

For those that inherit retirement accounts, the rules are similar to the original owner, however, there are two major exceptions: 1) Inherited Roth IRAs now require RMDs, and 2) the distribution calculations will use a different table. 

When must they be taken?

RMDs are to be taken before December 31st of the calendar year in which they are calculated. The one exception to this rule is that for a retiree’s first RMD, they may delay this first distribution to April 1 of the year following the calendar year in which they reach age 70 ½. However, there is one drawback, if you delay your first distribution to the next year, you have to take 2 distributions the following year. 

Ex. Mary turns 70 ½ in 2019 and elects to take her 2019 RMD on March 25, 2020. She is well within her right to delay this, but now she also still needs to take her 2020 RMD sometime before December 31, 2020, and must declare both distributions for her 2020 income taxes. 

While it might beg the question of why someone would choose to delay RMDs if it means having two taxable distributions in the same year, depending on a person’s income at age 70 ½ and when they might choose to retire, it may be more tax-efficient in some cases. 

For those who inherit retirement assets, there is no 1st-year delay to April 1st of the following year. RMDs must be taken by December 31st, following the year of the original owner’s passing. If the owner was already of RMD age, a final distribution based on the original owner’s life expectancy should be taken (if this had not already occurred prior to death). However, for those choosing to take a 5-year distribution method (allowed when the original owner was under 70 ½), no RMDs are required until December 31st of the fifth year after death, at which point the entire balance must be distributed. 

How are RMDs calculated?

Since you may be reading this article while on a holiday break, there is no need to go back to math class, and the calculations are relatively easy. It is in using the proper tables however that requires additional explanation. These tables can be found in IRS Publication 590-B.

The formula for calculating RMDs:

Below is an explanation of each table, along with an example:

Table III (Uniform Lifetime) – Should be used for:

  • Unmarried Owners,
  • Married Owners Whose Spouses aren’t More Than 10 Years Younger, and
  • Married Owners Whose Spouses aren’t the Sole Beneficiaries of Their IRAs)

RMDs Table

It is also important to note that depending on when the owner’s birthday falls, they may use age 70 or 71 to begin their first RMD. For those born in the first half of the year (prior to July 1st), they will use age 70, and those born in the second half of the year (July 1st or later) will use age 71.

Ex. Bob turned 70 on July 2, 2019, with an IRA balance on December 31, 2018 of $848,000. His required minimum distribution would actually not be required until 2020 as Bob never reaches age 70 ½ in 2019. In 2020, Bob’s will have reached age 70 ½, and his oldest age in that same year will be 71. If his balance on December 31, 2019 was $840,000 he would be required to take $840,000 / 26.5 for a total of $31,698.11 in RMD. 

Table II (Uniform Lifetime) – Should be used for:

  • Joint Life and Last Survivor Expectancy
  • For Use by Owners Whose Spouses Are More Than 10 Years Younger and Are the Sole Beneficiaries of Their IRAs

RMDs Table

Ex. Jim turned 70 on January 20, 2019, with an IRA balance on December 31, 2018 of $1,200,000. His sole beneficiary on his IRA is his wife Irene who is 15-years his junior. While he could use his own life expectancy factor of 27.4 from Table III (Uniform Lifetime) for a distribution of $1,200,000 / 27.4 for a total of $43,795.62, instead he can use Table II (Joint Life and Last Survivor using $1,200,000 / 31.1 for a total of $38,585.20, allowing him to distribute less from his IRA and preserve assets longer.

Table I (Uniform Lifetime) – Should be used for:

  • Single Life Expectancy
  • For Use by Beneficiaries

RMDs Table

In determining how to establish using the Single Life Expectancy method (Table I) it is important to note that the beneficiary’s remaining life expectancy is calculated using the age of the beneficiary in the year following the year of the IRA owner’s death, reduced by one for each subsequent year. 

Ex. John died on February 3, 2019, and the oldest age he would have obtained in 2019 was age 74. His balance on December 31, 2018 was $800,000, and he never took a distribution in 2019. His beneficiaries are his two children equally Mary age 49, and Jim 24, who have a bit of an age gap between the two of them. Assuming that neither of them wishes to disclaim their interest in the account or take a lump-sum distribution (before September 30, 2020), they will each need to transfer their 50% share into an inherited IRA into their own names before December 31, 2020. They should also look to satisfy their father’s final RMD before this transfer. In 2019, they distribute $800,000 / 23.8 (from Table III) for a total of $33,613.44. They do not get around to transferring their equal inheritances until March 20, 2020 at which point the account is balanced at $804,000, and so they each receive $402,000 in IRA assets. As the year proceeds their accountant informs them that they also each need to satisfy their own RMDs. To accomplish this, they will need to review the December 31, 2019 balance of their father’s original IRA which was $795,000. Since they each had an equal share, they will each need to calculate their RMD as follows: for Mary, she will need to take the balance of $397,500 (even though her balance has grown since) / 34.2 (since the oldest age she will be the year following her father’s passing is 50) for a distribution of $11,622.80. Jim, on the other hand, will calculate his RMD by using $397,5000 / 58.2 for a distribution of $6,829.89.

Additional special provisions?

  • RMD Aggregation – The IRS permits you to take the total of all of your pre-tax (i.e. Traditional, Rollover, SEP, and SIMPLE IRAs) RMDs from one account. However, you cannot combine RMDs across IRAs and employer plans. There is one other exception, if you have multiple 403(b) accounts, you may satisfy the total RMD from the 403(b) side  in total from one 403(b) account. 
  • Spousal Assumption of an Inherited IRA/Other Retirement Plan – For those who survive their partners and do not require immediate access to the retirement funds, they have the option of rolling over their spouse’s inherited IRA/other retirement plan into an IRA in their own name. This will be treated just like it was always their own IRA, and so RMDs can be postponed until the new owner reaches age 70 ½. The downside however, is if this option is taken, the owner will now be subject to early withdrawal penalties if they later need those funds before age 59 ½. 
  • How You Label Beneficiaries Matters – RMD rules on inherited retirement assets favors individual beneficiaries as opposed trusts or organizations. If you are going to be using a trust, you may want to check if yours is a see-through trust which looks past the trust and to the beneficiary for determining RMD payments. Improper planning could even lead to RMDs being based on the age of the oldest beneficiary. It is important to make sure beneficiaries are properly put into place and a trusted estate planner/attorney has reviewed your documents. 
  • Don’t need the money, don’t want to pay the taxes, and feel charitable? Well, you are in luck, thanks to current tax law, each Traditional IRA owner is allowed to distribute $100,000 annually as a Qualified Charitable Distribution (QCD). This distribution may only be taken after reaching age 70 ½, unlike the standard RMD which technically can be credited if distributed at any point in the year in which you reach age 70 ½. This provision may not be shared among spouses, but if each spouse has a Traditional IRA, they could potentially each reduce their taxable income dollar-for-dollar by the amount of the QCD up to $100,000 each. Lastly, this provision only exists for Traditional/Roth IRA owners (though it’s worth noting there is generally no tax-benefit to taking the QCD from the Roth).  
  • You cannot convert an RMD to a Roth IRA. Once you are of RMD age, all of your distributions up to the calculated RMD that are taken are considered distributed RMDs. If you transfer any amount from your pre-tax account to a Roth IRA up to the RMD amount, this will be considered a disallowed rollover, and you will have to remove it as an excess rollover contribution. You may convert other funds once the RMD has been removed.
  • In a similar fashion to being unable to convert RMDs to a Roth IRA, you may also not rollover an RMD even if it is into a pre-tax account. You may complete an asset transfer including that year’s RMD so long as the RMD is distributed by the end of the year.
  • It is possible to both contribute to, and be required to take RMDs from an employer-sponsored plan if you are still working past age 70 ½ and are more than a 5% owner in that employer!
  • Unlike most tax provisions that look at marital status at the end of the year, your marital status on January 1st of the year in which you are calculating your RMD status is used.

What does the future hold for RMDs? – Upcoming Legislation

Rules around RMDs have been fairly steadfast since Congress passed the Tax Reform Act of 1986, which began requiring taxpayers over the age of 70 ½ to start taking annual distributions from their tax-deferred defined contribution plans. That said, there have been times that the laws have been adjusted. 

For example, in 2008, the President signed the Worker, Retiree, and Employer Recovery Act of 2008, which allowed a one-time suspension of RMDs for the calendar year 2009, including an additional year given to beneficiaries receiving inherited retirement distributions effectively extending the “5-year period” to 6-years. 

Another recent change was the Protecting Americans from Tax Hikes (PATH) Act of 2015, which restored Qualified Charitable Distributions (QCDs) permanently (as permanent as any rule might be under the tax law) which had been for years extended only year-to-year causing last-minute tax-planning decisions. 

So what new changes can the public expect from RMDs? Well, just this year the house passed The Secure Act in what may be major legislation that could shake up the current rules around RMDs. Some of the biggest changes expected could be a proposed change from entirely removing the age cap of 70 ½ for those wanting to contribute to a Traditional IRA (including provisions to allow a spouse to contribute for a non-working retired spouse as well), as well as changing the RMD age from 70 ½ to age 72. 

Though many of these proposed changes benefit retirees, there is one proposed area that could do away with some of the more generous provisions to nonspousal heirs. Under the current law, a legal person can generally begin taking RMDs on inherited assets the year after the original owner passed away, now using a life expectancy table based on their own age. 

In effect this allows the heir to “stretch” the distributions of this plan over their lifetime and have more flexibility in how they are taxed (as they can always distribute more than the mandatory amount). With the proposed changes non-spousal beneficiaries may no longer be allowed to distribute this over their own lifetime but may be required to deplete this account over a 10-year window.

While major changes may be ahead, retirement planning both in the accumulation, and distribution phases are key to finding success not only in retirement but in overall wealth management and estate planning. Having a strong team of financial professionals can be a powerful tool that allows you to continue to meet your goals, no matter how the laws change. At My Financial Coach and through its strong partnership with Subject Matter Experts, you can plan on always being at the forefront of the ever-changing financial landscape.

Best,

Andrew J. Crosby, CFP®, ChFC®, RICP®

Lead Financial Coach

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