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Retirement Planning

The Required Minimum Distribution and What it Means for You

by
Gordon W. McNamee
on
10/30/2019
The Required Minimum Distribution and What it Means for You

Are you familiar with the rules regarding the Required Minimum Distribution — or RMD — as it applies to those who are 70 ½ or older? It is a tax code rule that mandates that people of that age or older take out a minimum amount from any traditional IRA, 401(k), or SEP IRA that they may own.

Though people who hold these accounts for their retirement may prefer to hold on to their qualified retirement savings plans a bit longer, the federal government does not allow this. They require that, at this point in a taxpayer's life, they begin to distribute assets a little at a time, and to pay taxes on the amounts that they liquidate. Failure to comply with the rule does not go unnoticed: in fact, when taxpayers don't take out the amount that is required, they end up having to fork over a penalty valued at half of the amount that they should have cashed out.

The rules regarding the Required Minimum Distribution are fairly strict, and allow for little room for interpretation. Each type of account has a specific amount that must be distributed, and taxpayers who try to finesse the requirement by overcompensating in distributions in one account to make up for shortfalls in the other will find their efforts are rejected. Excesses cannot be applied to shortfalls.

RMD Calculations

To understand how the RMD applies to you, start by looking at the calendar and figuring out when you officially become 70 ½. The year that happens in is the year of your first required distribution. Though you can push the distribution back as far as April 1st of the following year, those who do so only delay the inevitable rather than dividing it. They will end up having to take not one, but two distributions during that following year: the original distribution due in the year they turned 70 ½, and the distribution for the subsequent year.

So, if you turned 70 ½ in the first half of 2019, you can wait as long as April 1st of 2020 to liquidate the required amount for 2019, but you will also have to transact another distribution for 2020 by December 31st.

Example: 72-year-old Troy’s traditional IRA account balance had been $300,000 on December 31st of the prior year. Reviewing the Uniform Life Table, we see that the column labeled “Life” for age 72 indicates a factor of 25.6. This means that Troy’s RMD for his IRA account is $11,718.75 ($300,000/25.6). 

Taxpayers who are subject to the RMD should note that underpayment of the required minimum distribution can result in penalties. In the example above, if Troy failed to withdraw the $11,718.75 that the tax code requires, he would be subject to a significant penalty. How significant? The code requires that he be taxed 50% of the amount that he failed to distribute, which calculates out to $5,859. The only exception to this penalty is where the taxpayer justifies the failure and corrects their failure by taking the withdrawal shortly after it’s been discovered. This process involves significant extra work and a positive outcome is not guaranteed.

Further, depending upon what state you reside in, you risk the possibility of further penalties imposed by your local tax agencies. Taxpayers are strongly urged to adhere to the rules and withdraw the required amounts, even when their total income is less than the return-filing threshold. Though they are not required to file a tax return, they are still subject to the RMD requirements. Failure to comply can leave them vulnerable to the under-distribution penalty, even where no income tax would have been due.

Two tables are not illustrated because of their size: the Joint Life and Last Survivor Table, which is used to determine RMDs when the sole beneficiary is a spouse who is 10 years younger (or more) than the plan owner, and the Single Life Table, which is used for certain beneficiary RMD determinations. For table values that are not illustrated above, or for any other questions, contact a tax professional.

Taxpayers who are considering the amount to withdraw from their qualified retirement account should be mindful that although there is a minimum requirement based upon the calculation reflected above, any amount over the RMD may reduce the balance in the account (and therefore have an impact on the following year’s calculation) but cannot be applied or carried over to the next year’s requirement.

The calculation of the amount of the RMD has to be performed separately for each qualified retirement account that the taxpayer holds, though taxpayers who hold multiple accounts that are all of the same type can total up their accounts and take their RMD from any combination of those accounts, or even from just one account of the same type.

If you have retirement accounts and have reached the age of 70 ½ or are about to, here are some specifics on different types of accounts and some of the RMD requirements, as well as other important reminders and details.

  • Still-Working Exception – One of the first things you need to know is that if you are still working you may be able to delay taking your Required Minimum Distribution based upon an exception to the rule. Though the exception does not apply to either distributions to qualified plans to more-than-5% owners, or to IRAs (including those established in conjunction with a SEP or SIMPLE IRA plan), it does allow those who are still working to choose as their required beginning date (RBD) the later of the calendar year when they turn 70 ½ or the calendar year when they retire. This exception only applies to plans that the employer is maintaining, and it is important to note that this exception will not apply if the employer’s plan specifies that normal rules regarding required minimum distribution apply.
  • Roth IRAs – The Required Minimum Distribution requirements do not apply to Roth IRAs, and as long as the account owner is alive their funds can remain untouched and reserved for heirs (unless the owner needs the funds for their own expenses).  However, qualified designated Roth 401(k) and 403(b) plans remain subject to the requirements regarding distributions.
  • IRA-to-Charity Transfers – Transferring funds from an IRA to a qualified charity offers taxpayers a tax-advantaged way of minimizing the impact of the RMD. This particularly useful for those who are already in the habit of making large charitable contributions, as they can transfer up to $100,000 per year, exclude that distribution from income (thus lowering their adjusted gross income compared to what it would be if they took the RMD), and still count the distribution towards their RMD requirement. Though the distribution will not count as a charitable contribution, the lowered AGI can make a difference in other tax break categories such as passive losses, taxable Social Security income and medical expenses. No matter whether you itemize or not, the IRA-to-charity transfer offers the benefit of offsetting the IRA distribution requirement.
  • Beneficiaries – If the owner of a qualified plan or IRA dies, their beneficiary who inherits the plan is responsible for taking the required minimum distributions. That must be done no later than the end of the year after the original owner’s death. It is important to note that owners of qualified plans need to periodically review their listed beneficiaries to ensure that they continue to reflect their wishes. Many taxpayers fail to do this, and inadvertently leave their retirement account funds to a former spouse or someone else from whom they have become estranged over the years.

The more you learn about the nuances of the Required Minimum Distribution requirements, the more apparent it becomes that competent advance planning is essential. With the correct guidance, taxes on qualified plan distributions can be minimized or even eliminated, and where a taxpayer’s income is very low as a result of extraordinary losses or deductions, it may be beneficial for the amount distributed from the RMD to be greater than required. To ensure that you are being compliant in a way that optimizes your financial situation, contact a tax professional to start planning.

Gordon W. McNamee, CPA writes for TaxBuzz, a tax news and advice website. Reach him and his team at [email protected].

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Gordon W. McNamee

Gordon W. McNamee

Gordon W. McNamee is a Certified Public Accountant (CPA) based in Rancho Cucamonga, CA. Gordon W. McNamee can assist you with your tax return preparation, payroll, accounting and tax planning needs. <br /> <br /> 2021 is Gordon W. McNamee, CPAs 38th year in the profession. As as a former IRS agent (1984 through 1987), Gordon has been in public accounting since 1987. Gordon specializes in individual, corporate, HOA, trust, estate and payroll taxes. He also prepares financial statements and provides accounting & bookkeeping services. He enjoys making his clients feel at ease while providing a personalized professional service.

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