Given the uncertain future of Social Security and the decline in popularity of traditional pensions, taking initiative to save for retirement is more important than ever. Individual Retirement Accounts (IRAs) and employer-sponsored qualified retirement plans provide valuable, tax-favored opportunities. However, along with the benefits come certain rules. So what are the nuts & bolts of required minimum distributions?
The Internal Revenue Service (IRS) governs the distribution of these savings during retirement with the required minimum distribution (RMD) rules. The RMD is the minimum amount that must be distributed to retirement plan owners beginning in the year the owner turns age 70½.
Required Beginning Date
Minimum distributions must be made on or before December 31st of each year. However, the first required minimum distribution may be postponed until April 1st of the calendar year following the year the IRA owner reaches age 70½. This is the “required beginning date.”
For example, Amanda (a hypothetical case) turned 70 on March 5, 2014 and turns70½ on September 5, 2014. Her first RMD is due December 31, 2014, but it may be postponed until the “required beginning date” of April 1, 2015. Her second RMD would then be due on December 31, 2015.
Any participant in a qualified retirement plan who is not a 5% owner may postpone the required beginning date until April 1st of the calendar year following the year of retirement, if so allowed in the plan document.
Just as there are penalties for withdrawing money too soon, there are penalties for not taking the RMD. A 50% excise tax is imposed for failing to take these required distributions.
A Simpler Table
The final regulations in 2002 produced a simpler table for calculating the life expectancies that determine RMDs. Known as the uniform lifetime table, it reflects longer life expectancies, decreases the required minimums, and generally results in larger tax-deferred account balances.
Distributions Upon Death
With the reform, the single life expectancy table is generally used regardless of who is the designated beneficiary. Distributions must begin by December 31st of the year following the year of death and are based on the beneficiary’s life expectancy. If there are multiple beneficiaries, the life expectancy is based on the oldest beneficiary, or separate accounts may be established for each beneficiary.
Spousal beneficiaries may elect at any time to treat the owner/participant’s IRA as their own, and only spousal beneficiaries may roll over death benefits to their own IRAs. With the rollover option, the surviving spouse can wait to start distributions when he or she reaches age 70 ½. However, there is the possibility of inheritance or estate taxes on IRAs, depending on the circumstances.
The IRS Rules
Taxpayers who take IRA distributions in a series of “substantially equal periodic payments” may be able to change the method of calculating these payments without incurring a 10% early withdrawal penalty tax. The IRS now allows a one-time election to switch to the RMD method without incurring any penalties. The RMD method permits the taxpayer to recalculate the payment using the life expectancy tables and the account balance each year.
Failure to follow IRS regulations could be costly. Knowing the rules can help you plan ahead and take full advantage of the important tax benefits qualified retirement plans offer. Since Federal income tax rules are rather complicated, be sure to consult your tax professional for more information on RMDs.