Year-end is a busy time in the retirement distributions world. One transaction which requires close attention is a Required Minimum Distribution. The rules are somewhat confusing, and failures come with a costly penalty. Let’s review some of the key concepts.
When Should the First RMD be Taken?
The answer depends on the type of the retirement account. Generally, an IRA account holder or a retirement plan participant who attained age 70 ½ must withdraw their first Required Minimum Distribution (RMD) by the Required Beginning Date (RBD).
When is the Required Beginning Date?
For IRA account holders: The RBD is April 1 of the year following the year in which a retirement account holder turns age 70 ½. Only the first RMD receives an April 1 deadline. All future RMDs must be taken by 12/31 of each year.
Client Turned 70 ½ in 2012: Judy was born on 3/15/1942; she turned 70 ½ on 9/15/2012. Her RBD, the date by which she must receive her first RMD, is April 1, 2013. The amount of this RMD is based on the account balance as of 12/31/2011. Because only the first RMD receives an April 1 deadline, all of Judy’s future RMDs must be withdrawn by 12/31 each year. For example, the RMD for the year 2013 must be calculated using the 12/31/2012 value and withdrawn on or before 12/31/2013.
Client Turns 70 ½ in 2013: Jack was born on 6/15/1943. He turns 70 on 6/15/2013; he will have reached age 70 ½ on 12/15/2013. Since for IRA accounts the RBD is April 1 of the year following the year in which he/she turns age 70 ½, Jack’s RBD is 4/1/2014 and will be based on the 12/31/2012 account value. Because only the first RMD receives the delayed April 1 deadline treatment, all future RMDs must be taken by 12/31 of each year. In this case, the 2014 RMD will need to be taken by 12/31/2014. Thus for a client who turned 70 ½ in 2013, two RMDs will need to be taken in 2014, the 2013 RMD and the 2014 RMD.
For Retirement Plan Participants: The RBD also applies to employer‐sponsored retirement plans such as 401(k), profit-sharing, 403(b), and defined benefit plans. The RBD for plan participants varies depending on that participant’s level of ownership in the organization sponsoring the plan:
- A 5% owner: If a participant in an employer‐sponsored retirement plan owns MORE than 5 percent of the organization sponsoring the plan, that participant must begin receiving minimum distributions by April 1 of the year following the year in which the individual reaches age 70 ½, even if the individual continues working.
- Not a 5% owner: The RBD for plan participants who are not 5 percent owners of the organization sponsoring the plan, as defined above, is April 1 of the year following the later of: (1) the calendar year in which the employee attains age 70½, or (2) the calendar year in which the employee severs service from the employer maintaining the plan. It’s important to note that this provision is an optional feature and is not always offered by a retirement plan; therefore you should consult the Summary Plan Description as to availability of this provision.
What about Roth Accounts?
RMDs are not required for Roth IRAs. However, Roth 401(k) accounts are subject to RMDs. Thus, participants in Roth 401(k) plans may want to roll their Roth 401(k) balances to Roth IRAs the year before turning age 70 ½. Inherited Roth IRA accounts are subject to RMD requirements.
What if the RMDs are Not Withdrawn on Time?
Failure to withdraw RMDs on time results in what the Internal Revenue Service (IRS) calls “excess accumulations.” Excess accumulations can be subject to a penalty equal to 50 percent of the amount that ought to have been distributed from the account. This penalty is payable to the IRS.
Are There Exceptions to the Penalty?
If a reasonable error occurs, the IRS may waive the 50 percent penalty applicable to excess accumulations. Taxpayers in this situation should work with their tax preparer to complete IRS Form 5329, explain the error, and request a waiver of penalty.