Although required minimum distributions (RMDs) are now mandatory components of retirement plans, this was not always the case. RMD rules began to apply to qualified plans following the Tax Reform Act of 1986, after policy makers noticed that retirement account holders were saving the funds for their beneficiaries rather than their own retirement spending. Fast-forward to the current day, where the RMD rules have continued to evolve as a result of the SECURE Act of 2019 and SECURE 2.0 Act of 2022.
To help keep you informed, this blog will discuss the most important aspects of RMDs in their present form. We also encourage you to watch our 2-minute BFSG short with Paul Horn, CFP®, CPWA®, who gives a high-level overview of the most important things to know about RMDs.
Who needs to take an RMD?
An RMD must be taken in the year you reach age 73. Your employer retirement plan may have an exception for participants who continue to work after age 73. This exception, however, does not apply to individuals with more than 5% ownership, including attributed ownership, of the company that sponsors the plan. The age increases to age 75 beginning on January 1, 2033.
Retirement plans affected by RMD rules are:
- 401(k) Plans
- 403(b) Plans
- 457 Plans
- Traditional IRAs
- Simplified Employee Pensions (SEP) IRAs
- Savings Incentive Match Plans for Employees (SIMPLE) IRAs
- Inherited Traditional IRAs and Roth IRAs
Note: Defined Benefit and Cash Balance plans satisfy their RMDs by starting monthly benefit payments (or a lump sum distribution) at the participant’s required beginning date. Health Savings Account balances are not subject to the RMD rules.
When must an RMD be taken?
RMDs are due by the end of the calendar year to avoid paying an excise tax. Your first RMD can be delayed until April 1st of the following year; this is called the required beginning date. The taxation of the first RMD should be considered when deciding whether to take the money by the end of the year or delay it until the following year. If the first RMD is delayed, two taxable distributions will be made in the same year.
How much is distributed as an RMD?
For tax-deferred retirement plans, the RMD amount is calculated by taking the account balance (as of the end of the preceding calendar year) and dividing it by a value which estimates life expectancy. The IRS provides tables to determine this value based on the beneficiary’s age and the age of their spouse, if applicable. Prior to 2024, both pre-tax and designated Roth accounts were part of this calculation; beginning in 2024, however, designated Roth accounts are not subject to the RMD rules while the account owner is still alive.
An RMD can’t be rolled over, so it is not subject to the mandatory 20% Federal Income Tax withholding. Instead, the default tax withholding rate for an RMD is 10%. The participant can choose to withhold more or less than this 10%, or even elect to waive the withholding. However, even if the withholding is waived, the amount distributed will still be considered taxable income for the participant.
If you have more than one IRA, you must calculate the RMD for each IRA separately each year. However, you may aggregate your RMD amounts for all your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA.
If you have an account balance in more than one employer retirement plan (i.e., 401k or 403b), RMDs must be taken from each plan. Also, taking an RMD from an IRA does not satisfy the requirement to take the RMD from a plan. The RMD for each plan is calculated independently.
Exception: If you have more than one 403(b) tax-sheltered annuity account, you can total the RMDs and then take them from any one (or more) of the tax-sheltered annuities.
What about Inherited retirement accounts?
For inherited IRAs and inherited Roth IRAs, if the account was inherited before the SECURE Act 2019 was passed, you can take RMDs over your life expectancy. If you inherited the account after the SECURE Act 2019 was passed, the account must be depleted within 10 years of the account owner’s death unless the beneficiary is a spouse, a disabled or chronically ill individual, or a minor child until they reach the age of majority. There is also an RMD that you need to take each year, starting in 2025. Read our prior blog on navigating the complex rules of inherited IRAs.
What happens if an RMD isn’t taken?
The excise tax for failing to take an RMD used to be 50%. SECURE 2.0 lowered this to 25%; however, the excise tax may be further reduced to 10% if a correction is made within two years.
Prepared by Pension Pro. Edited by BFSG. Copyright 2024.
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