You may not need or even desire to take money out of your Individual Retirement Account (IRA) or your employer-sponsored retirement plan, but at some point you will be required to take withdrawals from these accounts. They are retirement accounts after all and they were not created to hold our money forever. This mandatory withdrawal amount is called your required minimum distribution (RMD). You can always take more than your RMD amount but you can’t take less. If you errantly withdraw less than the required amount, the shortfall is potentially subject to a 50% penalty (ouch!).
When do you need to start taking required minimum distributions?
In general, RMDs begin in the year we turn 70 ½. If your birthday is from January 1 – June 30, your first RMD will be attributed to the year you turn 70 since you will turn 70 ½ during the year you celebrate your 70th birthday. If your birthday is from July 1 – December 31, your first RMD will be attributed to the year you turn 71 since you will turn 70 ½ during the year you celebrate your 71st birthday. No one is quite sure where our Congressional leaders came up with the 70 ½ year figure although some have speculated they hatched this idea in a Washington, DC watering hole. Regardless of the rationale, it is the law at present.
How are they calculated?
RMDs are calculated by dividing your retirement account balance at the end of the previous year by a life expectancy factor based on your age.
|For example, Biff has an IRA account with a value of $1,000,000 on 12/31/14 and he turns 70 ½ on September 1, 2015. Since Biff celebrates his 70th birthday in the same year he turns 70 ½, the IRS Uniform Lifetime Table tells us to use a life expectancy factor (divisor) attributable to a 70 year old which equals 27.4. We divide 27.4 into the $1,000,000 to arrive at his RMD of $36,496 for the 2015 tax year.
When must they be taken?
Your RMD for a particular year must usually be taken by December 31 of that year. The only exception to this rule is for the first year you are required to take an RMD. For this first year only, you are permitted to wait up to April 1 of the following year to take your RMD without penalty. Please keep in mind that delaying this first RMD until April 1 of the following year will mean you will be required to take two separate distributions during that year as all RMDs (other than the first year RMD) are required to be paid out by December 31 each year.
The date you are required to take your first mandatory distribution is generally referred to as your required beginning date (RBD). For those who have a 401(k) or other employer-sponsored retirement plan, the RBD is the same April 1 date, unless they are still working for the company where they have the retirement plan. If the plan participant does not own more than 5% of the company and if the plan document permits, they can delay their RBD until April 1 of the year following the year they finally retire. This is sometimes called the “still working” exception but it only applies to required distributions from employer-sponsored retirement plans. It does not apply to IRA accounts. Additionally, it will not apply if the participant is not currently working for that company.
|For example, Brian has an IRA account with the local bank and a 401(k) plan with his employer and he is still working for the company sponsoring the 401(k) plan. Additionally, let’s assume Brian does not own more than 5% of the company he works for. When Brian reaches age 70 ½, he can delay taking distributions from his 401(k) account until April 1 of the year following the year he retires, regardless of his age. However, this “still working” exception does not apply to his IRA account. Brian will be required to take his RMD from the IRA account by no later than April 1 of the year following the year he turns 70 ½ years old.
How do distributions affect the earnings in my retirement account?
RMDs begin at less than 4% of the fair market value of your account and steadily increase each year For example, the life expectancy factor for a 70 year old IRA owner taken from the IRS Uniform Lifetime Table is 27.4. When we divide this factor into 100, we come up with 3.65 which represents the percentage of the account balance that must be withdrawn. Continuing on, the life expectancy factor for a 71 year old IRA owner is 26.5. When we divide 26.5 into 100, we get a distribution percentage of 3.78% (rounded up). Each year will produce a slight increase in this percentage.
As long as your earnings are more than 4% in your IRA during the initial, early years after reaching age 70 ½, and you are withdrawing only your RMD, your account value will continue to increase. Although the withdrawal percentage increases each year, this does not mean that your actual RMD, in dollars, will always be greater than the prior year. This will be determined by the actual investment performance of your account.
The Required Minimum Distribution rules can be quite confusing and there are different twists for different types of retirement accounts. We are very knowledgeable in this area and invite you to call us should you need any assistance with ensuring you stay compliant with these rules.