Unraveling Required Minimum Distributions

What to know when you have to take retirement payouts.

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Scott Holsopple

December is hectic and sometimes chaotic, but you need to add one more duty to your to-do list if you, or a loved one you help, is of the age where rules regarding Required Minimum Distributions apply to retirement savings. The general RMD deadline is December 31.

To ease the confusion associated with RMDs, here are answers to some common questions:

What’s a distribution? Distribution is retirement industry and Internal Revenue Service lingo for a retirement account withdrawal.

What’s a Required Minimum Distribution? Required Minimum Distributions are withdrawals that must be taken from a retirement plan account to avoid IRS penalties. Plans subject to RMDs include 401(k) and Roth 401(k), 403(b), 457*, IRA and Thrift Savings Plan –plans that allow participants to make pre-tax contributions and/or avoid capital gains taxes.

Why does the IRS require withdrawals? First, the government needs to ensure you’re not using your retirement accounts as a vehicle to pass money to heirs, thereby avoiding estate taxes. Second, the government needs to collect income taxes sometime because retirement accounts have many tax advantages: (1) pre-tax contributions allow people to afford larger investment contributions because the money hasn’t been reduced by taxes, (2) pre-tax contributions lower taxable income and (3) tax-deferred retirement accounts aren’t subject to the capital gains taxes people must pay on most other investments.

When do you have to start taking RMDs? People age 70½ or greater and no longer employed are required to begin taking distributions from most retirement accounts. The first RMD payment can be postponed until April 1 of the year following the year you turn 70½, but subsequent distributions must be taken by December 31 each year. Clear as mud? Here’s an example:

  • Your 70th birthday was November 16, 2011.
  • You will be 70 ½ on May 16, 2012
  • You’re required to take an initial RMD by April 1, 2013
  • You’re also required to take a 2013 RMD by December 31, 2013
  • Here’s another scenario:

    • Your 70th birthday was February 16, 2011
    • You were 70 ½ on August 16, 2011
    • Your first RMD must be taken by April 1, 2012
    • You’re also required to take a 2012 RMD by December 31, 2012
    • If you continue working past age 70½ (and you are not a 5 percent owner of the business offering the retirement plan), you can delay your RMD from your current employer only. You would need to satisfy RMD’s from all other accounts (401(k)s, 403(b)s, IRAs, etc.).

      How much is an RMD, and from which accounts must it be taken? The formula to determine RMD amounts is based on life expectancy and the ending account balance from December 31 of the year prior to the distribution. There are three life expectancy calculations: (1) Single Life, (2) Joint and Last Survivor and (3) Uniform Lifetime. Your individual situation will determine which life expectancy table to use. The IRS provides RMD calculation worksheets, and there are several online calculators. Plus, the institution that holds your account may provide the RMD amount. Ultimately, figuring the correct RMD amount is your responsibility, and you’ll pay a penalty if there’s an error – so double-check.

      There are different rules for taking withdrawals depending on which category of account you hold. Calculate each account you own separately for the appropriate RMD amount. Keep RMDs from different plan types separate because you can’t combine totals for one distribution. Then, if you have multiple IRAs you can take the total required amount from one or more IRA accounts to satisfy the payment. The same is true for individuals with multiple 403(b) accounts. You cannot combine 401(k) and 457 accounts for distribution.

      What penalties could I face if I don’t take an RMD? RMDs can be a convoluted hassle, but don’t stick your head in the sand and ignore them. The penalty for missing withdrawals within the required timeframe is a 50 percent tax on any amount not properly distributed. There are exceptions, but it’s best not to test the waters.

      The take-away to remember is that you’ll have to take periodic distributions from your tax-deferred accounts. Set calendar reminders that give you time to do calculations and request necessary paperwork. Seek the help of a tax adviser if RMDs become too complicated, and then you can take one thing off your to-do list.

      Nothing in this article should be construed as tax advice. Contact a qualified tax professional to discuss the tax implications involved in taking Required Minimum Distributions from your retirement plan as well as any other tax matters relating to your retirement plan options.

      *Though 457 plan accounts are subject to RMD rules like other retirement plan accounts, 457 accounts have unique rules governing some contributions and distributions because, unlike most other retirement plans, 457 plans are not categorized by the IRS as qualified. This 2010 Forbes article offers a comprehensive analysis of 457 plans.

      Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.