Understanding Minimum Distribution RequirementsSubmitted by MIRUS Financial Partners on February 26th, 2019
Getting Close to Retirement Age in PA?
One of the most complicated aspects of IRAs, and employer-sponsored retirement plans like 401(k)s, is figuring out the smartest ways to withdraw your funds, also called distributions. We get lots of questions about the regulations around IRA and retirement funds distributions from our clients in Lancaster County, Bucks, Berks, and York Counties. Some people prefer to keep the funds in place as long as possible as a financial safety net, to avoid taxing funds, or to try to hold on to the funds as an inheritance. However, these types of retirement plans come with distribution requirements that dictate how long you can defer payouts and also set amounts for the least amount you can withdraw from your account, also called a required minimum distribution or RMD.
Withdrawing more than the minimum amount from your IRA or employer-sponsored retirement plan comes without any additional penalties (though your distributions will be taxed.) However, if you withdraw less than the required minimum, you will be subject to a federal penalty.
Once you reach 70 ½ (or, in some cases, after you retire) the government requires you to make annual withdrawals from these types of accounts. These rules are calculated in ways that allow you to spread out the distribution of your entire interest in an IRA or retirement plan account over your lifetime.
Which Retirement Savings Vehicles are Affected by Required Minimum Distribution Regulations?
IRAs, SIMPLE IRAs, and simplified employee pension (SEP) IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to the same regulations.
Qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans, Section 457(b) plans and Section 403(b) all have similar RMD rules. Consult your plan administrator or a tax professional for specifics or exceptions in your plan.
How Long can You Wait Until You Start Withdrawing from Your Retirement Plan?
You can postpone distributions until the year you reach age 70½, or you can delay it until April 1 of the following year. Because your first distribution generally must be taken no later than April 1 following the year you reach age 70½, this April 1 date is known as your required beginning date.
Once you begin taking distributions, there are additional requirements. You must take your required minimum distribution for every following year by the end of each calendar year (Dec 31) until you die, or your balance is reduced to zero. That means that people who delay the first distribution (until April 1 of the year following the year, they turn 70½) will be required to take two distributions (double distributions) during that year.
However, you may be able to push back your required minimum distribution date if you meet all of the following requirements:
- You continue to work past age 70½
- You are still participating in your employer's retirement plan
- Your retirement plan allows this exception
- You own less than 5% of the company
In this scenario, you could push back your distribution date to April 1 following the calendar year in which you retire. Once you take your first distribution, subsequent distributions must be taken no later than December 31 of each calendar year.
When is it a Good Idea to Postpone Distributions from IRAs and Retirement Plans like 401(k)s?
There are many reasons people might want to delay retirement plan payouts. Some people continue to work and contribute. Others don’t need the income immediately and prefer to let their IRA or employer-sponsored retirement account accrue interest.
For others, postponing payouts as long as possible may allow them to stay in a lower income tax bracket. However, if you choose to wait until April 1, following the year you turn 70½, you may have to take a double distribution, which could increase taxable income for the following year.
What Happens if You Don’t Follow the RMD Regulations?
The government allows you to withdraw more than required from your IRAs and retirement plans. However, if you don’t take your required minimum distribution, federal penalties apply. You will be subject to a 50% excise tax on the difference. For Example: If your RMD for year one is $10,000, and you withdraw only $5,000, you may be subject to an excise tax of $2,500 (50% of $5,000).
Talk with a Financial Advisor or tax professional if you want more information on your situation.
Can an Annuity Contract Satisfy the RMD Requirements?
Some people want to reinvest IRA distributions into Annuity. Your purchase of an annuity contract with the funds in your IRA or retirement plan satisfies the RMD rules if all of the following are true:
- Payments are made at least yearly
- The annuity is purchased on or before the date that distributions are required to begin
- The annuity is calculated and paid over a period that does not exceed those permitted under the RMD rules
- Payments, with certain exceptions, do not increase If you participate in a 401(k) or similar plan, or an IRA, you may also be able to use up to 25% of your account balances (up to a maximum of $125,000 from all accounts, indexed for inflation) to purchase a qualifying longevity annuity (or QLAC). The value of the QLAC is disregarded when you calculate the amount of RMDs you are otherwise required to take from your account each year. Payments from the QLAC can be delayed up to age 85 and are treated as satisfying the RMD rules when paid. The rules can be complicated, and QLACs are not right for everyone, so be sure to consult a qualified professional for further information. (Note: Any annuity guarantees are subject to the claims-paying ability and financial strength of the annuity issuer.)
Required minimum distributions are generally subject to federal (and possibly state) income. However, if you have ever made after-tax contributions to your IRA or plan, a portion of the funds distributed to you may not be subject to tax. If your IRA or plan contains any after-tax contributions, consult a tax professional to determine your eligibility.
If your RMD is a qualified distribution from a Roth 401(k), 403(b), or 457(b) account, you may not have to pay income tax on that distribution. Generally, an RMD is not taxed if your Roth IRA account satisfies the five-year holding period requirement. Even if your Roth IRA RMD is not categorized as tax-free, you will only owe taxes on the profits or interest accrued on your contribution — your original contribution amount is returned free of tax.
Mark A. Vergenes is President of MIRUS Financial Partners, 110 E. King St., Lancaster, PA; 717-509-4521 or email@example.com.
Investment Advisor Representative offering securities and advisory services offered through Cetera Advisor Networks LLC., member FINRA/SIPC, a broker/dealer and a Registered Investment Adviser. Cetera is under separate ownership from any other named entity. Neither MIRUS Financial Partners nor Cetera Advisor Networks LLC. give tax or legal advice.