By Jeremy T. Rodriguez, JD
Most people are aware of the tax concept, Required Minimum Distributions or “RMDs.” These are the tax rules that force you to take a distribution from your IRA or qualified plan, even when you don’t want to. Moreover, that distribution is usually taxable, and it cannot be rolled over!
The calculation is always the same: you divide the account balance as of December 31st of the previous year (adjusted for any outstanding rollovers and transfers) by the appropriate life expectancy factor. What often confuses people are the starting points and the applicable expectancy factor. Use the checklist below to keep some of these rules straight:
- IRA Owner: RMDs must be made by April 1st following the year you reach age 70 ½. After that initial distribution, the deadline shifts. You still receive an RMD, but it must be made by December 31st. Because of this, waiting until the April 1st deadline means while you pay taxes on two RMDs in the same year.
- Company Retirement Plan Owner: If you are still working when turn 70 ½ and you do not own more than 5% of the company, you don’t have to take RMD from the company plan where you work until you eventually retire. While this is technically an optional rule for plans, many have adopted it. Be aware, the exception only applies to your current employer’s plan. If you have a retirement account with a previous employer, RMDs from that plan must be made by April 1st following the year you reach age 70 ½.
- Spouse Beneficiary (Both IRAs and Company Retirement Plans): Surviving spouses do not have to begin RMDs from an inherited IRA or company retirement plan until the deceased spouse would have reached age 70 ½. If the spouse remains a beneficiary, they would use the life expectancy factor from the single life table. However, unlike non-spouse beneficiaries, a surviving spouse gets to use the table and “recalculate” each subsequent year which results in smaller RMDs. Finally, the surviving spouse can always rollover the assets to their own IRA or company retirement plan (subject to plan rules). In that case, the RMD rules for owners apply (see above).
- Non-Spouse Designated Beneficiary (IRA): A non-spouse designated beneficiary doesn’t have the options a surviving spouse has. RMDs must begin by December 31st of the year following the death of the original IRA owner. They cannot rollover the assets to their own account, cannot do a 60-day rollover, and cannot make additional contributions to the account. To calculate the first RMD, you would use the appropriate life expectancy factor from the single life table. However, going forward you wouldn’t use the table. Instead, you subtract one from the previous year’s life expectancy factor. That means someone needs to be keeping track!
- Non-Spouse Designated Beneficiary (Company Retirement Plans): The start date for RMDs is the same. However, unlike non-spouse beneficiaries that inherit IRAs, those that inherit company retirement plan accounts have two extra considerations:
1. The plan does not have to allow the stretch. That brings into play the default RMD rules, which depend on when the account owner died. If the account owner died before RMDs started, we use the 5-year rule. If the death was after RMDs began, we use the remaining life expectancy of the decedent. Either way, the end result is we are not using the beneficiary’s life expectancy. You can avoid either of those scenarios by directly rolling over the inherited plan assets to an inherited IRA.
2. Inherited retirement plan accounts can be directly rolled over to an inherited Roth IRA. That includes pre-tax accounts.
- Charities and Trusts (IRAs and Company Retirement Plans): Charities can never be designated beneficiaries and therefore bring into play the default RMD. If a charity is named as a beneficiary along with other living individuals, you will want to consider paying out the charity or establishing separate accounts. However, each of these options have separate due dates that you must meet.
On the other hand, a trust can qualify as a designated beneficiary, meaning we get to use the life expectancy of the oldest trust beneficiary. These are often referred to as “see-through trusts.”
This is just a summary and additional factors, such as multiple beneficiaries, could change what might seem like the best option. However, these rules and the attendant considerations aren’t something you should toss aside. The consequences are grave. If you miss an RMD, you will owe an excise tax equal to 50% of the missed RMD! Even worse, there is no statute of limitations on the issue. That means it stays with you, and potentially your beneficiaries, forever. Therefore, it’s vital that you work with a qualified advisor to satisfy the RMD requirements.