Almost every single client we meet with over the age of 65 asks “what about the required minimum distributions from my IRA?” and with good reason! Even if the specifics are not understood, what most do know is that this is very important to get right.
The first element to understand is when a distribution is required. If you are the original owner of an IRA, that means the year in which you turn 70 ½. IRS rules do allow you to delay that first distribution up to the tax filing deadline for that year. However, this is not usually recommended because you would end up with the first and second required distributions in the same calendar year, and the additional income could push you into a higher tax bracket. If you have inherited an IRA, different rules apply, which we’ll get to later.
Another situation that can cause confusion is if you are still working. Due to our increasing life expectancies, continuing to work past age 70 ½ is becoming more and more common. If this is you, it is very important to understand that even though you can still contribute to an IRA (including SIMPLE IRAs and SEP IRAs), the required distribution rules also apply. If you have a 401(k) instead, you generally do NOT have required minimum distributions as long as you are working (and the plan allows). Still another twist to this scenario is that if you have a 401(k) and are a 5% or greater owner of the business (common for the self-employed), the “still working” exception is not allowed and you must begin your RMDs at age 70 ½.
So far we’ve been talking about rules for original account owners. If you have an inherited IRA, then the RMD’s will begin the year following the death of the original owner. The amount required is calculated from an IRS table based on the beneficiary’s age. The exception to this is if you are a spousal beneficiary, and elect to re-register the inherited IRA in your own name. If so, then your RMD’s will begin at your age 70 ½. The last twist for inherited IRAs applies to Roth IRAs. If you are the original owner of a Roth, you do not have any required distributions during your lifetime. However, the Roth IRA beneficiary is required to take distributions, though these distributions are not taxable income.
The second piece to understand is where the RMDs must be taken if you have more than one retirement account. In some cases, IRS rules allow distributions to be consolidated. This is referred to as RMD aggregation. Unfortunately, it is easy to get wrong, and opens the client up to various tax penalties.
IRA (including SEP and SIMPLE IRAs) required distributions can be calculated separately for each account, but then the aggregated total can be taken from any one or a combination of those accounts. Similarly, multiple 403(b) accounts can be calculated and aggregated. However IRA and 403(b) distributions cannot be combined. RMDs from other employer plans, such as a 401(k), cannot be aggregated at all. Each RMD must be calculated and taken separately from each plan.
So how do you take your RMD? If you are approaching 70 ½ or have inherited an IRA from someone else, it’s a good idea to contact your financial planner or the account custodian (where the account is held) early on to confirm the process for distributions and your options. The reason why all of this is so important is that failure to take an RMD will potentially trigger a significant IRS penalty – 50% of the required amount not taken.
If you do not need the RMD for your immediate spending, it can be re-invested in another account and continue to grow. A caveat here is that the RMD cannot be rolled over to another retirement account. This would create an “excess contribution”, which if not corrected, would result in a 6% IRS penalty each year that it remains in the wrong account.
The good news here is that if you have an ongoing service relationship with a CFP® or other trusted financial professional, they most likely already have this on their radar and are working on your behalf to ensure your RMDs are processed correctly.