The Required Minimum Distribution
If you turned 70 on or before June 30th, 2018, you have moved into a new phase of retirement planning. The IRS may now require that you take a minimum distribution from your retirement accounts beginning this year.
What is the RMD and when does it need to be taken?
RMD is an amount of money that is required to be removed from your qualified accounts each year. The IRS allowed for money to be added over the years into a qualified retirement account [IRA, 401(k), 403(b), etc.] before tax and allowed the assets to accumulate tax deferred. The RMD is a way for the IRS to make sure that the account that you have deferred tax on to this point is withdrawn over your lifetime, or the lifetimes of your beneficiaries, so that the amount becomes taxable.
Each person with a qualifying account is required to make their first distribution by April 1st of the year following the year they turn 70.5. After the first year, you are then required to take a distribution from the account by December 31st of each following year.
Which accounts does it affect?
Accounts that had assets added to it on a pretax basis and that have grown tax deferred are going to be subject to the RMD rules. This includes IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s and 403(b)s.
If you are working past 70.5, you cannot make contributions to an individual plan and you must start the RMD for those plans. However, if you are 70.5 years old and still working at an employer that has a qualified employer plan, you may add to this plan and you do not have to take an RMD from that plan as long as you are not more than 5% owner of the company.
If you have both account types, are 70.5 and still working, you do have to take an RMD from your individual accounts but you do not have to take from your employer plan. You are allowed this exemption to the rule while you are working. Once you stop working the employer plan is now subject to the RMD rule.
When Stan leaves the company both the IRA and the 401(k) are subject to the RMD rule and he is now required to take the minimum from both accounts. It makes no difference whether Stan leaves the money in the 401(k) or moves it to the IRA, the RMD amount is the same and is required for both accounts.
How is it calculated?
Many people believe that the RMD is calculated as a percentage of the account value but that is not the case. To calculate your RMD simply take your account balance on December 31st of the previous year and divide it by the number that corresponds to your age at the end of the year on this IRS RMD Table. Each individual account has its own RMD so you will want to calculate each account separately. If you are not comfortable performing the calculation yourself or want to double check, there are many online RMD calculators available.
How do I take it?
Stan would be required to take a total of $26,415.09 ($18,867.92 + $7,547.14) from his accounts by April 1st, 2019. He is only required to take the total, it does not matter which account(s) he takes it from and in what proportions. He could take the amounts listed from each account or he could take all from one and none from the other. As long as he takes the total by the deadline the IRS mandate is satisfied.
As discussed above, this first distribution is for 2018 and he has until April 1st, 2019 to take it. After the first distribution, he is required to take an annual distribution by December 31st every year after, including December 31st, 2019. Note that he will recalculate the RMD amount each year using the same method discussed above.
Taking two RMDs in a single tax year could have the effect of some income being subject to a higher marginal tax rate, reduced deductions or a change in the treatment of capital gains, qualified dividends and social security. Taking that first distribution by December 31st, 2018, would have helped him avoid these pitfalls but would have increased his income in 2018, possibly causing their own pitfalls. Speak to a trusted advisor regarding your situation to make sure you are making the best decision for you.
It is the responsibility of your custodian to calculate and report the RMD to you each year, but it is your responsibility to make sure that it is met. Also, it is the account holder’s responsibility to verify that the amount given to them by their custodian is correct, so make sure to use the above-mentioned table to verify your RMD. If you fail to take your RMD or any part of the RMD in a given year, you will be subject to a penalty on the undistributed amount of 50%.
The penalty will be taxable income to Stan which may affect the taxation of other income sources or could bump him to a higher tax bracket. This is an easy mistake to make but a very expensive one.
What can I do with the money?
Once you have paid tax on the distribution you are free to spend it, save it or reinvest it in another, non-IRA account. The point of the IRS requirement is not to have you spend the money, it is to have you pay tax on the money.
If you are charitably inclined, the IRS does allow your RMD (or a portion of your RMD) to be directed to charities of your choice. If you distribute the funds directly to the charities through your custodian this amount will not be included in your taxable income but will satisfy your RMD for that year. This is known as a Qualified Charitable distribution (QCD). Be sure to speak to an advisor regarding this strategy as there are certain limitations that may affect the deductibility of the donation.
The RMD rules can be confusing with one account but, if you have more than one account or you are still with an employer where you have a 401(k), they can become downright overwhelming. Be sure to give yourself enough time before your deadline to understand your situation so that you can satisfy your requirement and avoid a costly penalty.
*Stan’s example is for educational purposes only. Each individual situation is unique. The piece should not be seen as a recommendation.