Understanding IRA Required Minimum Distributions (RMDs)
The money you contribute to a traditional Individual Retirement Account is not counted as income in the year you contribute it. As a result, the contribution is put into the account without paying any tax. The government allows you to delay paying tax in order to encourage you to save for your retirement. After you reach the age of 70 1/2, the IRS requires you to begin taking minimum distributions from your traditional retirement accounts. Roth accounts are not subject to RMDs. Neither are accounts sponsored by your current employer when you own less than 5% of the company.
The rules that apply to retirement plan accounts and traditional IRAs can be confusing, especially when it comes to determining an individual’s required minimum distributions. I have listed below the 10 fundamental laws underlying the required minimum distribution scheme, as set forth by Natalie Choate in her book “<>Life and Death Planning for Retirement Benefits, 6th Edition 2006. Note, these are basic principles and many rules have at least one exception.
- RMDs start at a particular time. The starting point for lifetime required distributions is age 70 1/2.
- Annual distributions must be taken by December 31 each year. Once RMDs begin, the participant (or beneficiary) must take a distribution every calendar year, no later than December 31. There are several exceptions to this rule. For instance, the 5-year rule does not require annual distributions.
- Each year’s RMD is determined by dividing the prior year-end account balance by a factor from the IRS table.
- There is no maximum distribution. The formula tells you the minimum required distribution. The rules impose no maximum distribution. The participant or beneficiary is always free, as far as IRS is concerned, to take more than the minimum.
- Taking more than the required amount in one year does not give you a “credit” you can use to reduce distributions and a later year. Each year stands on its own. Taking larger distributions, however, does indirectly reduce later RMDs by reducing the account balance.
- The plan may be stricter than the regulations. Just because a participant or beneficiary qualifies for the life expectancy payout method under the law does not mean he or she will actually get to use it. The plan must allow it also.
- The RMD cannot exceed 100% of the account balance.
- Distributions before the first Distribution Year do not count. The first year for which an RMD is required is called a “first Distribution Year.” Distributions in years prior to that, such distributions after age 59 ½ that can be taken without penalty, have no effect on the computation of the RMD for the first (or any other) distribution year, other than indirectly by reducing account balance.
- The distribution does not involve an election. With one exception, the determination of the applicable distribution period (determined by reference to the applicable IRS life expectancy table) for benefits, either during life or death, does not involve and “election” on the part of the participant or the beneficiary. The applicable distribution period is what is based on the identity or age of the participant and beneficiary. The exception is, if the participant dies before his required beginning date for distributions, leaving his benefits to a Designated Beneficiary, the beneficiary may elect between the life expectancy payout method and the 5-year rule.
- Regulations “overrule” the Internal Revenue Code. You cannot compute a person’s RMD simply by following the Internal Revenue Code. The IRS regulations have fundamentally altered the Congressional scheme in several ways.
Your RMD can be distributed as a lump sum at any time during the year or you can set up automatic monthly withdrawal which will satisfy your RMD gradually throughout the year. When your RMD is transferred out of your retirement account you can have federal or state taxes automatically withheld.