Do you know the complex rules regarding Required Minimum Distributions?

As you accumulate assets inside a traditional IRA you do not pay any taxes until you start taking withdrawals. Any amount that comes out of a traditional IRA is a taxable event for both federal and state income taxes. Beyond some special exceptions to the rule the IRS wants you to wait until age 59.5 before you start taking those withdrawals. If you take withdrawals out of an IRA before age 59.5 you can be subject to a 10% excise penalty on the distribution.

What many owners of traditional IRAs do not know is that when you reach the age of 70.5 the IRS states that you have to start taking withdrawals out of your IRA. These withdrawals are called required minimum distributions and are based on life expectancy tables published by the IRS. The IRS has let you contribute tax-free dollars in your IRAs and also let those earnings grow tax-free. At age 70.5 they want you to start taking withdrawals and paying taxes on those distributions. If you miss your RMD it is one of the harshest excise penalties in the whole tax code at 50%! This means that you pay a penalty tax of 50% on any untaken RMD. This can be a very complex matter, so let’s take a look at some rules for RMDs that are not well known.

What if you are still working when you reach age 70.5?

If you are still working at age 70.5 you might get to delay your RMDs inside your qualified plan. First, you will need to make sure that your employer plan has a “still working” exception to RMD rules. Most plans that are current have these provisions built in; however, you will want to double check with your employer. These provisions only apply to employer plans and never applies to IRAs, including SEP IRAs and SIMPLE IRAs. If your plan has this provision then any assets you have in that employer plan are not subject to RMDs until you terminate employment. If you have IRA money outside of your employer plan, you must still take RMDs from those assets. Also, please note, that if you are a participant in a plan and you are more than a 5% owner of that company you must still take your RMD. This determination is made at on the day you turn age 70.5.

Once you have reached age 70.5 and have terminated employment you must begin taking distributions in the year of separation from service. Your first RMD you have until April 1st of the following year to take your RMD. However, if you wait until April 1st you will have two RMDs that must be satisfied for that year, which could have a big impact in which tax bracket you are subject to.

RMDs must be satisfied separately for each account, except IRAs.

If you have multiple traditional IRAs you have your choice to which IRA account you must satisfy the aggregate of all the RMDs from. For example, let’s say you have three IRAs that each have $50,000 in them, for a total of $150,000 and according to IRS life expectancy table you must take out at least 5% of your IRA accounts. You can choose to take $2,500 from each IRA or you can take $7,500 from one of them. All that matters is you must take out $7,500 before December 31st. Now let’s take the previous example and add another account for $50,000, however, this account is still in an employer plan and you have terminated from services a long time ago. Your total RMD amount will now be $10,000, however, you must satisfy the RMD by taking $7,500 from your IRAs and another $2,500 from your employer plan. This is very important to understand the difference. If you choose to take $10,000 from the IRA accounts then you will have an unsatisfied RMD of $2,500 and a 50% excise penalty to go along with that.

Now, what happens if you have turned age 70.5 and you decide to rollover your 401k into an IRA? You can certainly do that, just know that the RMD must be taken before you can initiate any rollover. This is because RMDs cannot be rolled over and all distributions from an employer plan to an IRA are considered rollovers.

Are RMDs required for Roth 401ks or Roth IRAs?

Again, it depends!! Roth IRAs are not subject to RMD rules and can keep accumulating tax-free for as long as the Roth IRA owner is alive. Once the Roth IRA becomes an inherited Roth IRA then it becomes subject to RMDs the year following the owner’s death.

If you have a Roth 401k plan and have turned age 70.5 then you are required to take an RMD for that year. Once the RMD is satisfied you can roll over to a Roth IRA and are no longer required to take RMDs. If you rollover your Roth 401k before you turn age 70.5 then no RMD would be required.

The rules for RMDs are very complex and the penalties that can come along with missing an RMD are very harsh. Having a financial advisor to help guide you through the process can be very beneficial. MSMF has helped out hundreds of clients navigate through IRA and RMD situations. Please let us know if we can help you.

Cody Reading is a financial advisor at MSMF Wealth Management. He specializes in retirement planning strategies and believes that the best part of his job is helping clients reach their financial objectives. In his spare time, Cody enjoys hiking, cooking, traveling, spending time with his family, and attending Cardinals and Blues games.