Introduction
What are required minimum distributions? A required minimum distribution (“RMD”) is the minimum amount that must be withdrawn from your retirement account each year when you reach age a certain age. These rules apply to practically all retirement plans, including defined benefit plans, IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, 457(b) plans, and other defined contribution plans. While the rules affect almost every type of plan, they are generally only an issue for those with defined contributions plan accounts (e.g., 401(k) or profit-sharing plans) and IRA accounts.
Calculations and Start Dates of Required Minimum Distributions
There are three tables that can be used to calculate minimum distributions. Table I is the Single Life Expectancy, which is used for a beneficiary that is not the participant or his or her spouse. Table II is the Joint Life and Last Survivor Expectancy table. This table is used for participants that are married to a spouse that is 10 or more years younger than the participant. The last table is the Uniform Lifetime Table. This is probably the most commonly used table and is applied to 1) all unmarried account owners, 2) married owners whose spouses aren’t more than 10 years younger than them, and 3) married owners whose spouses aren’t the sole beneficiaries of their accounts.
In December of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act which, among other things, modified the starting date for required minimum distributions. Essentially, if you were born before July 1, 1949, your distributions must begin by April 1st of the year following the calendar year in which you turn 70½ years old. On the other hand, if you were born after June 30, 1949, your RMD start date is April 1st of the following calendar year after you turn 72.
On major difference between IRAs and retirement plans is that a participant in a retirement plan can delay RMDs until they retire. For example, if an employee works until he or she is 73, then RMDs do not have to begin until April 1st of the year following retirement. IRA owners cannot delay RMDs based on their working status. Importantly, the ability to delay RMDs only applies to a plan sponsored by the participant’s current employer. If the participant has an account balance in a retirement plan with a previous employer, their RMDs must begin at the appropriate age (i.e., age 70 ½ or 72) even if they are still working.
Required Minimum Distributions After the Account Owner Dies
The rules get a little more confusing once the account holder dies. If the participant was currently receiving RMDs prior to passing, then he or she must receive one for the year of death. These distributions are generally payable to the participant’s estate. For the year’s following the participant’s death, the distribution rules depend on whether the beneficiary is a spouse or non-spouse beneficiary. The rules were also significantly changed by the SECURE Act.
If the beneficiary is a surviving spouse, he or she can delay starting RMDs until the later of 1) when the participant would have reached age 72 (or 70 ½ if born before July 1, 1949), or 2) when the spouse reaches age 72 (or 70 ½ if born before July 1, 1949). These rules were unchanged by the SECURE Act.
What did change were the distribution rules for non-spouse beneficiaries. Under the old rules, all non-spouse beneficiaries could “stretch” those distributions out over their own life expectancy. In other words, non-spouse beneficiaries could use the RMD tables to take annual distributions as opposed to taking everything out all at once. By doing this, they are only paying taxes on the annual RMD as opposed to entire account value. This tax planning strategy was employed by beneficiaries who did not immediately need the inherited account.
However, under the SECURE Act only “eligible designated beneficiaries” can “stretch” RMDs. “Eligible designated beneficiaries” include surviving spouses, disabled individuals, chronically ill individuals, minor children, or individuals who are not more than 10 years younger than the account owner. Everyone else must withdraw the entire account within 10 years of the date of death. It does not matter when the withdrawals occur or how much. All that matters is that the account is completely empty by the end of the 10-year period.
Fixing a Missed Required Minimum Distribution
The IRS imposes a stiff excise tax on someone who fails to take an RMD. The penalty is equal to 50% of the amount that should have been withdrawn! Thankfully, the IRS recognizes that this is a common error and has established a procedure for correcting the mistake and requesting relief from the penalty.
The first step is to issue the missed RMDs immediately. If the mistake occurred within a retirement plan, the plan should use the procedures set forth in the IRS’s Employee Plans Compliance Resolution Program (“EPCRS”) to fix the error. However, in most cases this will not remove the excise tax. Instead, the participant must also file Form 5329 to report the mistake and request relief. This is important because the IRS has taken the position that the statute of limitations does not begin to run until Form 5329 is filed. Thus, imitating an ostrich and ignoring the problem simply isn’t an option.
Takeaways
Required minimum distributions ensure that an individual’s retirement account, whether employer or IRA, is distributed over his or her lifetime. The IRS places the responsibility for this on the participant. Therefore, it is vital that participants understand when they must begin RMDs and how those distributions are calculated. Finally, if an RMD is missed the participant must immediately take the required distribution, report the error to the IRS, and request relief from the excise tax. The IRS will generally grant the relief if the individual self-reports, acts quickly, and ensures that the mistake will not reoccur.