Required Minimum Distributions – 7 Things You Need to Know

The first wave of Baby Boomers hitting age 70 ½ began in 2017. This was the age when required minimum distributions had to begin for those turning 70 ½ on or before December 31, 2019. The SECURE Act, passed at the end of 2019 has raised the age to begin RMDs to 72 beginning on January 1, 2020. RMDs need to be taken from IRAs, 401(k)s and other retirement accounts.

Here are 7 things you need to know about required minimum distributions.

The penalties can be steep 

The rules were changed a number of years ago to require custodians such as Schwab and Fidelity to report the amount of your annual required minimum distribution to the government. In the past this had not been the case. This was part of an effort to enforce the taking of these distributions and the payment of the taxes associated with them. The penalty for not taking an RMD is steep, 50% of the amount not taken in addition to paying the taxes due.

As an example, if your RMD is $20,000 and you don’t take it you would owe a penalty of $10,000 on top of the taxes associated with the $20,000 distribution from your retirement account.

Be aware of the total required minimum distribution 

If you have multiple retirement accounts you will likely receive a separate RMD amount for each account. Note that the total of your required minimum distributions is what counts, you can generally take the entire amount of the distribution all from one account or from some or all of your various accounts as long as the total amount taken is correct. There are exceptions to this, so be sure to check with your custodian or a qualified tax or financial advisor to ensure you take the correct amounts for all accounts as required.

Timing matters 

Your first required minimum distribution will be for the year in which you turned 70 ½ for those who reached this age on or before December 31, 2019. For example, if you turned 70 on January 1, 2019 you would be 70 ½ on July 1, 2019 and you would have a required distribution for calendar year, 2019.

If your 70th birthday was September 1, 2019, your first distribution is not required until the year you turn 72, which would be 2021.

For your initial RMD only, you are not required to take the distribution until April 1 of the calendar year following the year in which you turn 70 ½ or now 72. For the someone who turned 70 on January 1, 2019 that would be April 1, 2020, for someone reaching age 72 on September 1, 2020 their initial RMD could be deferred until April 1, 2021.

However, all subsequent RMDs must be taken by December 31 of the appropriate year. Delaying the initial distribution until April 1 of the following calendar year would mean that you would be taking two distributions and paying taxes on both for the same calendar year. Often for this reason I suggest taking the first distribution in the year that it applies to, for example by December 31, 2019 in the January 1, 2019 birthday example.

How on earth is this calculated?

Your required minimum distribution for a given year is calculated based upon your age and the total of your retirement account(s) at December 31 of the prior year. The calculation is based upon the tables in IRS Publication 590.

For example if you are 75, married with a spouse who is not more than 10 years younger than you, and your IRA account balance was $500,000 at the end of 2019, your RMD for 2020 would be approximately $21,834 using the table. I generally rely on calculations by the custodian for a number of reasons, but it is always a good idea to double check. There are a number of online RMD calculators including this one.

Required minimum distributions are not always required 

If you are 70 ½ or older (or 72 or older for those to whom that age applies) and still working, there is a specific exception to the RMD rule. This pertains only to the 401(k) or similar retirement plan of your current employer. Additionally, it only applies if you are less than a 5% owner of the company. If both conditions are satisfied you do not have to take an RMD on that plan. Any other IRAs, an old 401(k), or similar accounts will still have a required minimum distribution. Your company must elect to offer this exception, so it is best to check with your retirement plan administrator if you are in this situation.

Inherited IRAs and required minimum distributions 

Note the rules below are for inherited IRAs that were inherited by non-spousal beneficiaries on or before December 31, 2019. The SECURE Act changed the rules, in some cases, for non-spousal beneficiaries so the explanation below will no longer apply in many cases for new inherited IRAs for non-spousal beneficiaries on or after January 1, 2020. More on this in a future post. 

Inherited IRAs are a specific type of account that usually comes into play with a non-spousal beneficiary. As an example, a parent who is a widow or widower might leave their IRA account to their adult children.

Let’s say the mother is a widow with a $100,000 IRA and she names each of her two adult children as beneficiaries.  Upon her death each child would have some options including setting up an inherited IRA account which has some specific rules.

If the mother had already started taking required minimum distributions from her IRA, then the children would need to continue taking RMDs from their inherited IRA accounts. However, their distributions would be based upon their life expectancy tables resulting in smaller distributions then would have been required by their mother. This allows the kids is to preserve and grow the inherited IRA account.

Roth IRAs and required minimum distributions 

One of the major benefits of a Roth IRA account is that the owner is not required to take required minimum distributions. This might be a factor among many in deciding whether a Roth IRA is the right way to go.

Note inherited Roth IRAs have different rules for non-spousal beneficiaries. If this is your situation you should contact a financial advisor who understands this issue.

Certainly, this list is not an exhaustive list. Required minimum distributions play an important part in both your retirement planning and potentially your estate planning. If you have questions, make sure you contact a tax or financial advisor who understands this complex area, especially with some new rules under the SECURE Act now in place.

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