Required Minimum Distributions (RMD’s) are amounts that a retirement plan owner must withdrawal annually in the year they reach 70 1/2 (potentially later if they are still working at 70 ½). If the account is an IRA or if the account owner is a 5% owner of the business sponsoring the plan, the RMD must begin once the owner turns 70 ½. If they miss a required minimum distribution, the penalty is 50% of the required amount not withdrawn.
A person must first decide when to take their first RMD. The required beginning date (RBD) is generally April 1st of the year following the year the qualified plan owner turns 70 ½. If they wait until the year following the year they turn 70 ½ they would then be required to take their 2nd RMD that same year, by December 31st. Based on IRS tables the person would withdrawal almost 8% of their plan assets in the year of their required beginning date, if they wait to take their first RMD until the RBD.
By waiting until the year following the required beginning date the taxpayer could be pushed into a higher tax bracket. General tax planning advises deferring income as long as possible, however this may not the ideal approach. By doubling up on RMD’s the extra income may affect the taxability of their Social Security. It could also affect the tax benefit of certain itemized deductions. Also, if the person turns 70 ½ in 2012 they may want to take their first RMD in 2012 due to uncertain tax law.
If someone is in an employee retirement plan, the required beginning date is the same April 1st as the IRA owner, unless they are still working at the company where they are a plan participant. They can then delay their RMD’s until they retire from that company. Any employee plans at a different company do not qualify for the delayed RMD’s. The still working rule allows them to delay their RBD to April 1st of the year following the year they finally retire.
The first RMD is due by April 1st of the year following the year a person reaches 70 ½. All subsequent RMD’s must be taken by December 31st of the applicable year. If a person fails to take their RMD they will owe a 50% excise tax on the amount they have failed to withdrawal. There is potential relief from the 50% penalty if the taxpayer can demonstrate reasonable cause for failure to take the distribution.
You may be wondering how the IRS will ever know if someone has not taken their required distribution. IRA custodians are required to notify the IRS of all IRA owners who are subject to required distributions. They are not required to disclose the actual amount and the notice will only state that the distribution is due. The custodian completes IRS Form 5498 which has a box indicating the RMD is required. The form is required to be sent to the account owner and the IRS by May 31st.
Since 2003 the custodians have been required notify account owners if they need to take a distribution. Now that the custodian is informing the client and the IRS, it is less likely that the IRS will waive the penalty if the distribution is “missed”. This is another reason to make sure all your clients are taking the appropriate retirement plan distributions on a timely basis. This gives you another chance to meet with clients and explore other opportunities.
In the year the IRA owner passes away the RMD must be taken by the beneficiary. There has been some confusion on this point, however the Final Regulations substantiate that the named beneficiary must take any required minimum distribution not taken by the IRA owner in the year of death. The beneficiary, not the estate, must take the year of death RMD and the beneficiary will then pay tax on that distribution. It will be reported on the beneficiaries Form 1040.
Required Minimum Distributions are calculated based on IRS issued tables. The three tables are published in IRS Publication 590. These actuarial tables project life expectancies. To calculate the RMD you take the account balance as of December 31st of the prior year and divide the balance by the life expectancy factor. Once the required distribution has been determined the client can decide how much to take and when.