Understanding Required Minimum Distributions (RMDs)
Published On: October 17, 2019
Written by: Ben Atwater and Matt Malick
As we plan for the end of 2019, one of our tasks is to determine which retirement account owners have taken some, all or none of their required minimum distributions (RMDs) year-to-date. With this is mind, we thought it would be a good time to help you better understand the ins and outs of the RMD.
Retirement accounts allow individuals to save in a tax-advantaged manner. The contributions are often tax-deductible, and the account’s growth is tax-deferred. In these cases, however, investors don’t get off tax-free forever. Rather, you need to pay taxes upon your withdrawals from IRAs, 401(k)s and the like. Because these accounts are intended to help you fund your retirement, Congress designed the plans to require that you withdraw funds upon reaching age 70½.
Like most things Congress does, RMD rules can be complex. So, let’s take a few minutes to look at the basics.
RMD rules generally begin after age 70½. However, if you continue working after age 70½ and aren’t a 5-percent owner of the company, you can delay your required beginning date for RMDs associated with that employer’s plan until you retire.
Additionally, you can also roll outside plans (IRAs and inactive 401(k)s) into your current employer plan to avoid RMDs while still working and being an active participant in your current employer plan. Any outside account that you don’t combine with the active employer plan, however, will continue to require RMDs.
You can also donate your RMD to charity and not have it count toward your taxable income. For more information on this strategy, please see the piece we emailed on October 3, 2019 entitled IRAs, RMDs and Charitable Giving.
When an individual reaches age 70½, he must take his first RMD by April 1 of the following year. This is a bit confusing because subsequent RMDs are due by December 31st of each year. For example, if you turned 70 on June 20, 2019, then you would reach age 70½ on December 20, 2019 and your first RMD would be due by April 1, 2020. However, your 2020 RMD would also be due before December 31, 2020.
As a note of caution on first year RMDs, if you have income in 2019 that you don’t expect to have in 2020, then delaying your first RMD to 2020 may make sense from a tax standpoint. But, in this case, you would need to take both the 2019 and the 2020 RMD in 2020.
RMD distributions are federally taxable at your marginal tax rate. For this reason, most people turning 70½ take the first distribution in the year they turn 70½ to spread out the tax liability, unless there is a specific tax reason not to do so. For example, you are still working in 2019, but plan to be retired by 2020.
We calculate RMDs by dividing the account balance from the end of the previous calendar year by a life expectancy factor that the IRS provides.
For example, assume your IRA had a balance of $1,000,000 on December 31, 2018. We use this prior year-end IRA value for the calculation. If you turned 73 in 2019, we find age 73 on the table and the corresponding applicable distribution period denominator of 23.8. By dividing $1,000,000 by 23.8, we come to $42,016.81, which is the RMD amount you must take from your IRA by Dec. 31, 2019.
With IRAs you can aggregate the account balances and take one distribution to meet the RMDs from multiple accounts. You cannot do this with 401(k)s. If you have inherited accounts, you generally cannot aggregate them together unless they are IRAs from the same deceased owner or inherited from a spouse and designated as your own IRA.
If you don’t take the RMD by the due date, you could owe a 50% tax penalty plus the ordinary income taxes you’d owe on the distribution.
For the most part, all retirement accounts (ERISA covered qualified retirement plans and IRAs) are subject to the RMD rules. However, Roth IRAs are different. When an individual is alive, she is not required to take an RMD from Roth IRAs. However, Roth accounts in 401(k)s, 403(b)s and the federal Thrift Savings Plan are subject to RMDs after age 70½, so it’s optimal to roll these plans to Roth IRAs at retirement.
For those with non-spousal inherited IRAs, the RMDs begin the year after the death of the decedent no matter the age of the beneficiary. We also calculate these using IRS tables, although different tables than for non-inherited IRAs.
As you can see, something so seemingly simple as an RMD can get quite complex. If you have any specific questions in this area, please feel free to email or call us.