From Choo Choo Trains to Required Minimum Distributions

Posted by Saaib Uppal, CPA

Spoon FeedThink back to your early childhood when your parents would try to get you to open your mouth and take in a spoonful of food. “Choo! Choo! Here comes the train!” That might be one of the last instances you remember of someone requiring you to take something. So quickly the tables turn and you are required to give, rather than take. Chores, homework, and bills are just some examples that I can think of. It will not remain that way, however. The IRS has made sure, through Required Minimum Distributions (RMDs), that you must take from your retirement accounts once you meet certain criteria, whether you wish to take them or not.

So what are the details on these RMDs? Well, it depends whether you hold an Individual Retirement Account (IRA) or an account in a qualified plan such as an employer sponsored 401(k), 403(b), or 457(b). If you are the owner of an IRA, you are required to take your first RMD by April 1st of the year after you turn 70 ½. Your second RMD must be made by December 31st of that same year and going forward, your yearly RMDs must be made by December 31st. The amount of your RMD is computed based on the total of your IRA accounts, but you may withdraw your entire RMD from one particular account or allocate it as you wish.

The rules are similar if you are dealing with other qualified plans. However, one exception with other qualified plans is that you have the option of delaying your RMDs until the year you actually retire if it is after you turn 70 ½, as long as you do not own more than 5% of the employer that sponsors the plan. If you do, you have to follow the rules that apply to IRAs. Unlike IRAs, you must calculate and make a RMD for each individual qualified plan separately.

Now, the IRS wouldn’t want you to wait too long and not be able to take advantage of your savings later on in your life. Not buying it? I didn’t think so. The truth is that the IRS is looking to stop people from accumulating retirement accounts and then passing the funds onto their beneficiaries through inheritance (and in the process defer taxation). The RMDs ensure that these distributions occur during your lifetime and that they are they create taxable events.

So now you know the situations that lead to a RMD, but how do you know the calculation? You must use IRS tables that are published in Publication 590. These tables calculate your RMD based on your prior December 31st balance and take into account a life expectancy factor. (Bet your parents didn’t do that when they were loading you up on spinach!) Your plan administrator or available online tools should be able to assist you with this feature, if necessary.

You can, of course, withdraw more than the calculated RMD. By definition, the reverse is not true. If you don’t withdraw the amount calculated for your RMD as a minimum, you face federal penalties that can be 50% of the amount that should have been withdrawn. This would be in addition to your ordinary income taxes.

As a plan sponsor, it is important that you recognize those participants who are due for RMDs so that they can avoid these penalties. Your plan administrator must be aware so that the necessary paperwork and other work required for these distributions can be a smooth process. Whether it will be as smooth as the spoon that was going into that participant’s mouth in childhood, we don’t know. What is certain is that a bumpy ride on this distribution process holds larger consequences than a messy shirt.

Photo by wka (License)