Navigating the Labyrinth of Required Minimum Distributions

Since the passage of the Tax Reform Act of 1986, taxpayers have been required to withdraw previously untaxed dollars from their qualified plan and IRA accounts. These withdrawals are called Required Minimum Distributions or RMDs. Historically, those at and over the age of 70 ½ must take annual withdrawals from their tax deferred accounts including IRAs, SEP IRAs and 401(k) plans. An RMD is calculated by dividing the previous year’s balance by a life expectancy factor issued by the IRS. For rules that have remained relatively unchanged for over 30 years, RMD policy has had quite an overhaul starting with the changes made by the SECURE Act in 2019 and then, again, with the CARES Act in 2020. As a result of these changes, account owners and beneficiaries have three sets of RMD rules for 2020, 2021, and 2022.

The required minimum distribution rules came into effect in the late 1980s with the passage of the Tax Reform Act of 1986. Plans affected by RMD rules are:

  • 401(k) Plans
  • Roth IRAs (RMDs not required while the original owner is still living)
  • 403(b) Plans
  • 457 Plans
  • Traditional IRAs
  • Simplified Employee Pensions (SEP) IRAs
  • Savings Incentive Match Plans for Employees (SIMPLE) 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.

The SECURE Act, passed into law in late 2019, changed the age at which accounts subject to RMD rules had to start receiving RMDs. If the account holder reached age 70 ½ in 2019, the prior law applied and the first RMD was required by April 1, 2020. If the account holder reached age 70 ½ in 2020 or later, they must take their first RMD by April 1 of the year after turning age 72. Sounds easy, right? But wait…

In 2020, the CARES Act waived RMDs for account holders, including individuals who reached age 70½ in 2019 and had an RMD due in 2020, or had their first RMD due by April 1, 2021. The waiver did not delay distributions in defined benefit and cash balance plans.

However, in 2021, the CARES Act waiver for RMDs was not extended. That means account holders that are subject to RMD rules must make the required distributions for 2021.

  • If you reached age 70½ in 2019, your RMDs due in 2020 were waived. You had a 2021 RMD due by December 31, 2021, based on your account balance on December 31, 2020.
  • If you reached age 72 in 2021 (and didn’t reach 70 ½ in 2019), your 2021 RMD is due by April 1, 2022, based on your account balance on December 31, 2020. Your 2022 RMD is due by December 31, 2022, based on your account balance on December 31, 2021.

If you’re still employed by the plan sponsor of a 401(k) and are not considered to be a more than 5% owner, your plan may allow you to delay RMDs until you retire. The delay in starting RMDs does not extend to owners of traditional IRAs, Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs) and SARSEP IRA plans.

One more twist…

In November of 2020, the IRS announced the update of the life expectancy tables that are used to calculate the annual amount of RMDs. This change brings the tables more in line with the fact that Americans are living longer than assumed in previous calculations. The finalized rules related to the updated tables will apply to distributions in calendar years beginning on or after January 1, 2022.

It’s crucial that account owners become familiar with the changes in the rules pertaining to RMDs. Mistakes can be costly: The IRS assesses a 50% federal penalty tax on the amount of the RMD that should have been taken but wasn’t. So, working with your tax consultants and plan’s service providers is important when making decisions regarding RMDs.

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