2016 was the first year that the baby boom generation reached age 70 ½, and millions more will hit that milestone in the years ahead. The gift from the IRS is that they must begin withdrawing funds from their traditional individual retirement accounts and employer-sponsored retirement plans, such as 401(k) plans.
Overview of RMDs
Individuals cannot keep retirement funds in their accounts indefinitely. The RMD rules force individuals to begin taking distributions from retirement accounts beginning at age 70 ½. These distributions are fully taxable and subject to ordinary income tax rates. The IRS penalizes those taxpayers who do not comply with the RMD rules with a 50% excise tax penalty on the amounts not distributed.
The RMD rules do not apply to the original owners of Roth IRAs. The reason for this is that Roth IRA distributions are not taxable, so the government does not care whether individuals withdraw amounts from these accounts. However, Roth IRA accounts must be withdrawn by the heirs after the death of the Roth IRA owner.
RMDs must be taken from any account to which an individual made tax deferred contributions or had tax deferred earnings including:
- Traditional IRAs
- Inherited IRAs
- Rollover IRAs
- Simple IRAs
- SEP IRAs
- KEOGH Accounts
- 401(k), 403(b), and 457(b) Employer Plans
Individuals who are more than 5% owners of a company, must take an RMD when they turn 70 ½ even if they are not retired. However, if you are in an employer sponsored plan and are still working at age 70 1/2, and do not own more than 5% of the company, then you can delay taking your first RMD until the year you stop working.
Calculation of RMDs
The amount of your annual RMD is determined based on the value of the retirement accounts and the owner’s life expectancy. For IRA accounts, the RMD must be calculated separately for each account; however, the RMD amount can be taken from a single IRA account or from a combination of them. However, for Inherited IRAs, the calculation and distribution amount must be taken from each separate account of the individual.
For employer sponsored retirement plans such as 401(k), 403(b) and 457(b) plans, the RMD must be calculated separately and the distributions must be made separately from each respective account.
Planning Opportunities
In the year that an individual turns age 70 ½ the RMD distribution can be delayed until April 1 of the following year. This can defer taxable income into the subsequent tax year. However, doing this causes two RMDs to be received in the subsequent year, so planning is required to determine whether this causes the individual to be pushed into a higher tax bracket. If so, then the benefit of delaying the tax may be outweighed by the effect of the higher tax rate.
Congress has also made permanent a rule that allows taxpayers over age 70 ½ to donate up to $100,000 from their IRAs directly to a qualified charitable organization. These direct donations will count as your RMD for the year of the donation. These direct charity distributions are not taxed to the individual donor and, thus, the donor has neither income nor a deduction from these direct RMD distributions. Planning for these direct charity distributions may make sense in some years and should be discussed with your tax professional.
