What are Required Minimum Distributions (RMDs)?
Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty. The RMD rules are calculated to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don't just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime.
When Must RMDs be Taken?
Your first required distribution from an IRA or retirement plan is during the year you reach age 70½. However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year.
Since this first distribution generally must be taken no later than April 1 following the year you reach age 70½, this April 1 date is known as your required beginning date. All required distributions must be taken no later than December 31 of each calendar year until you die, or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year —your first year's required distribution and your second year's required distribution.
Example:You have a traditional IRA. Your 70th birthday is December 2, 2017, so you will reach age 70½ in 2018. You can take your first RMD during 2018, or you can delay it until April 1, 2019. If you choose to delay your first distribution until 2019, you will have to take two required distributions during 2019 —one for 2018 and one for 2019. This is because your required distribution for 2019 cannot be delayed until the following year.
There is one situation in which your required beginning date can be later than described above. If you continue working past age 70½ and are still participating in your employer's retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own 5% or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.
Examples:You own more than 5% of your employer's company and you are still working at the company. Your 70th birthday is on December 2, 2017, meaning that you will reach age 70½ in 2018. So, you must take your first RMD from your current employer's plan by April 1, 2019 —even if you're still working for the company at that time.
You participate in two plans —one with your current employer and one with your former employer. You own less than 5% of each company. Your 70th birthday is on December 2, 2017 (so you'll reach 70½ on June 2, 2018), but you'll keep working until you turn 73 on December 2, 2020. You can delay your first RMD from your current employer's plan until April 1, 2021 —the April 1 following the calendar year in which you retire. However, as to your former employer's plan, you must take your first distribution (for 2018) no later than April 1, 2019 —the April 1 after reaching age 70½.
What If You Fail to Take RMDs as Required?
You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 50% excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year.
Example:You own one traditional IRA and compute your RMD for year one to be $7,000. You take only $2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at least $7,000 as a distribution but have only taken $2,000, your RMD exceeds the amount of your actual distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50% of $5,000).
Technical Note:You report and pay the 50% tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts." The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to "reasonable error" and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return and attach a letter of explanation. The IRS will review the information you provide and decide whether to grant your request for a waiver.
As always, we hope you find this information useful. If you have any questions regarding RMDs or would like to learn more, contact Portfolio Solutions® at (248) 689-1550!
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