Required Minimum Distributions

You may have heard of the term Required Minimum Distributions, or RMDs, but what exactly does it mean? Required Minimum Distributions are minimum amounts that a retirement plan account owner must withdraw annually, starting with the year he or she reaches 72 (70 ½ if you reach 70 ½ before January 1, 2020). Over the next two weeks, we’ll be covering RMDs on both personal accounts and inherited accounts.

Retirement accounts are tax-deferred, meaning you have not yet paid tax on your principal balance or the gains within your account(s). Account holders are therefore required to withdraw a minimum amount from their retirement funds, and pay tax on that money, each year after they reach age 72 (because the IRS wants their tax money at some point). If it weren’t for RMDs, you could leave these accounts to family or friends as an inheritance without the IRS ever collecting any tax on that money if your beneficiary didn’t make withdrawals. 

Per the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), which became law on December 20, 2019, the RMD age was changed to 72 from 70 ½. This allows for investors to delay having to take the forced distributions for an additional year and a half. This may not seem like a big deal, but it can allow for individuals to take advantage of certain strategies such as Roth conversions for longer periods of time. As we stated earlier, money in a retirement account, such as a 401(k) or IRA, has not yet been taxed, so once you start taking distributions that money is going to be taxed as ordinary income. Proper planning for this additional income later in life is vital as it can have an effect on your Medicare premiums in addition to the taxation of your Social Security.

2020 has been a rough year in many ways, and fortunately for investors the government has recognized that. The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, waives required minimum distributions during 2020 for IRAs and retirement plans. Fortunately, this allows for inventors to keep that money invested and continue to grow tax-deferred while also lowering their 2020 tax bill. This too could allow for the implementation of certain planning strategies that are beneficial in lower income years. With the exception of 2020, traditionally, you must take your RMD by December 31st of the current year. 

If an account owner fails to withdraw an RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.

So, how are RMDs calculated? Generally, an RMD is calculated for each account by dividing the prior years’ December 31 balance of that IRA or retirement plan account by a life expectancy factor that IRS publishes in Tables in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). Choose the life expectancy table to use based on your situation.

• Joint and Last Survivor Table – use this if the sole beneficiary of the account is your spouse and your spouse is more than 10 years younger than you
  
• Uniform Lifetime Table – use this if your spouse is not your sole beneficiary or your spouse is not more than 10 years younger
  
• Single Life Expectancy Table – use this if you are a beneficiary of an account (an inherited IRA

Although the IRA custodian or retirement plan administrator may calculate the RMD, the IRA or retirement plan account owner is ultimately responsible for determining the proper amount of the RMD. RMDs can be confusing from the perspective of knowing which accounts you have to take from and how much. Also, it’s important to understand what impact it’s going to have on the rest of your plan. “How is this going to affect my health insurance premiums and Social Security?” For those reasons, it’s important for individuals to work with a financial professional to understand the effect it’s going to have on their overall situation.  

Next week we’ll continue with the topic of Required Minimum Distributions and as they pertain to inherited accounts. 

Derek Prusa, CFA, CFP® and Ben Webster, CFP®

Co-Founders and Owners of Aspire Wealth