The ABCs of RMDs

Nearly everyone with a tax-deferred retirement account is required to start taking minimal withdrawals at some point. Knowing the different rules for IRAs and qualified plans may avoid a costly error.

In general, participants in employer-sponsored retirement plans and IRA account owners must start taking lifetime required minimum distributions (RMDs) soon after they turn 70½. The RMD rules apply to all qualified plans, including 401(k), 403(b), and 457(b) plans. In addition, minimum withdrawals also apply to employer-sponsored IRAs, including SEP, SAR-SEP, and SIMPLE accounts. Complicating matters further, while designated Roth accounts and qualified plans are subject to lifetime RMDs, Roth IRAs are not.

It is the responsibility of plan participants and IRA owners to make sure that they withdraw the correct amount each year from their account. Failure to do so can result in stiff penalties.

Here, then, is a quick guide to highlight the RMD rules that apply to both IRAs and qualified plans to help account owners and participants avoid potential pitfalls.

RMD Timing
IRAs (including traditional, SEP, SAR-SEP, SIMPLE, but not Roth):

• In general, individuals are required to take their initial RMD by December 31 of the year in which they turn 70½, although the initial RMD can be deferred until as late as April 1 of the following year. In that case, two RMDs will be required the following year. For example, Sarah turns 70½ in 2015. She can either take her first RMD in 2015 or delay until as late as April 1, 2016. Assuming she delays until 2016, Sarah will need to take two RMDs in 2016. And she will be required to take one each year thereafter by December 31.
• An individual who is 70½ or older is eligible to participate in a SIMPLE IRA, assuming that all SIMPLE IRA eligibility requirements have been satisfied. However, the individual must still take minimum distributions.
• An individual 70½ or older is eligible to participate in a SEP IRA, assuming that all SEP IRA eligibility requirements have been satisfied. However, the individual also must take minimum distributions.
• Roth IRAs are not subject to lifetime RMDs for either the account holder or a surviving spouse. A non-spouse beneficiary is required to take minimum distributions.

Qualified Plans (including 401(k), 403(b), 457(b):

• Unlike with an IRA, investors generally are able to delay their initial RMD until April 1 following the year in which they turn 70½ or the year in which they retire—whichever is later. This option is available to those participants who are less than 5% owners of the business sponsoring the plans. Participants who own 5% or more of the business sponsoring the retirement plan must take their first RMD by April 1 following the calendar year in which they turn 70½, regardless of retirement age.
• Although it is uncommon, a plan may specify that all participants take an RMD at 70½, regardless of work status. (Check the summary plan description (SPD) for your plan’s rules.)

RMD amounts
IRAs (including, traditional, SEP, SAR-SEP, SIMPLE):

• RMD calculations are based on the value of the accounts on December 31 of the preceding distribution year—and on the life expectancy of the account holder, based on the IRS’ Uniform Lifetime Table. If the account holder’s spouse is the sole designated beneficiary, and more than 10 years younger than the account owner, the Joint Life and Last Survivor Expectancy Table is used instead.
• Investors with multiple accounts must calculate the RMD separately for each IRA owned (including SEP and SIMPLEs). However, the resulting total RMD amount may be taken from any one or multiple IRAs. Multiple accountholders may want to consider consolidating or rolling over separate IRAs into a single account to simplify the RMD process.

Qualified Plan (including 401(k), 403(b), 457(b)):

• Like IRAs, RMDs are based on the account value on December 31 of the preceding distribution year—and on the life expectancy of the account owners, using the IRS’ Uniform Lifetime Table. If the account owner’s spouse is more than 10 years younger, the Joint Life and Last Survivor Expectancy Table is used instead.
• In general, individuals who have more than one employer-sponsored qualified plan must calculate and take an RMD from each separate account.
• An exception is 403(b) plans: Individuals still need to calculate the RMD for each account separately, but they can withdraw the total amount from any one or more of their accounts.
• Unlike Roth IRAs, designated Roth 401(k), 403(b), and 457(b) accounts are subject to lifetime RMDs.

(For more information, see my blog, “IRAs: RMD Mistakes to Avoid.” )

Tax Implications 
IRAs and Qualified Plans:

• Distribution amounts drawn from deductible (pretax) contributions and earnings are taxed as ordinary income, subject to federal and state income tax (if applicable).
• The portion of distributions applicable to nondeductible (aftertax) contributions potentially can be recovered tax-free. It is the IRA owners’ responsibility to keep track of their basis, whereas with qualified plans, it is the responsibility of the plan sponsor.
• A penalty of 50% is applied for failure to take an RMD. The penalty (reported on IRS Form 5329) is 50% of the amount that was due to be distributed, but wasn’t. The IRS has leeway to waive the penalty for good cause.
• You are not permitted to roll over an RMD to either an IRA or a qualified plan.

Frequently Asked Questions
To further help you understand the lifetime minimum distribution rules, we offer answers to some frequently asked questions:

Q. Am I allowed to take more than the RMD amount? 
A. Yes.

Q. Can a distribution above the RMD amount taken in one year be applied to the RMD for a future year? 
A. No.

Q. Can I arrange to have an RMD of a qualified plan distributed from my IRA or vice versa?
A. No. If you participate in more than one qualified plan, your RMD for each plan is determined separately and distributed from its respective plan. However, if you have multiple IRAs, you can withdraw the total RMD amount from any IRA account or accounts you choose.

Q. Can I roll over my RMD to an IRA, Roth IRA, or other eligible retirement plan? 
A. No. If you choose to roll over your RMD, it will be treated as an excess contribution and potentially would be subject to taxes and/or penalties.

Q. If I convert my traditional IRA to a Roth IRA, would I still have an RMD?
A. Anyone, regardless of age, can convert traditional IRA assets to a Roth IRA. Although the amount of the RMD is required to be distributed prior to the conversion, RMDs would cease for all future years. For example, Tom’s 2015 RMD is $5,000. Tom must distribute his RMD prior to converting his IRA to a Roth IRA. Assuming the rest of his IRA is converted, Tom will never be required to take another RMD. 

For additional information on RMDs, refer to my blogs, “IRAs: FAQs about RMDs”  and “IRAs RMD Mistakes to Avoid.”

This is being provided for general educational purposes only and is not intended to provide legal, tax, or  investment advice. Please consult with your financial advisor for more detailed information or for advice regarding your individual situation.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

Traditional IRA—This is an individual retirement savings account in which contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an after tax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax-deductible, but withdrawals during retirement are generally tax-free.

SEP IRA—A Simplified Employee Pension Plan is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP IRA plan for your business, you and any eligible employees establish your own separate SEP IRA; employer contributions are then made into each eligible employee's SEP IRA.

SAR SEP IRA—A Salary Reduction Simplified Employee Pension Plan is a simpler alternative to a 401(k) and is available only to companies with 25 or fewer employees. It gives employees the opportunity to make contributions to their SEP accounts with pretax dollars and reduce their current year's net income. Also called a 408(k) plan.

SIMPLE IRA—A Savings Incentive Match Plan for Employees' IRA is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees' retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or non-elective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

Qualified Retirement Plan—This is a savings plan that is allowed certain tax advantages because it meets criteria spelled out in the IRS Code and in the Employee Retirement Income Security Act [ERISA] of 1974. Employers can take tax deductions for any contributions they make to an employee's account. Employee contributions and investment returns are tax-deferred until withdrawn. Contribution limits apply, as do penalties for early withdrawal.

403(b)—A qualified retirement plan for certain employees of public schools, tax-exempt organizations, and certain ministers. Generally, retirement income accounts can invest in either annuities or mutual funds. Also known as a tax-sheltered annuity (TA) plan.

457(b) plan—A 457(b) is a nonqualified, deferred-compensation plan established by state and local governments, tax-exempt governments, and tax-exempt employers. Eligible employees are allowed to make salary deferral contributions to the 457(b) plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan.