IRAs and employer sponsored saving or retirement plans (“Plans”) are a great way to save for retirement. Typically, they defer income tax for many years and Plans often include employer contributions and other benefits. While IRAs and Plans can be corner stones of a successful retirement, they are subject to complex required minimum distribution (“RMD”) rules.
Required minimum distributions or RMDs are based on the account balance at December 31 of the prior year. RMDs equal the applicable account balance multiplied by a fraction based on age and life expectancy statistics. Thus required minimum distributions change each year. The IRS and most major investment firms publish guidelines and tables you can use to help calculate your RMD.
The required minimum distribution RMD rules generally require an IRA owner or Plan participant to take distributions from IRAs and Plans starting with the year in which he or she reaches age seventy and a half (i.e. 70.5 years old). RMDs are not required from Roth IRAs and Roth Plans until the Roth owner dies. Sometimes Plan RMDs can be deferred until retirement after age seventy and a half.
The first RMD is due by April 1 (not April 15) of the year after the year in which an IRA owner or Plan participant reaches age 70.5. The second and subsequent RMDs are due by Dec. 31 of the year. Failing to take required minimum distributions on time can lead to a large penalty tax.
You must calculate RMDs separately for each IRA and Plan. While you must take a Plan RMD from the Plan that generates the RMD, you may take IRA RMDs from any or all of your IRAs.
The required minimum distribution rules may be illustrated by the following example. John is born August 20, 1948 and has two IRAs and Plan benefits from three businesses of which John owns 6%.
1 John turned 70.5 years old Feb. 20, 2019 so his first RMD is for 2019;
2 Even though John is not retired, John must take Plan required minimum distributions starting with the year in which he reached age 70.5 (2019) because John owns at least 5% of each Plan sponsor business;
3 Normally, RMDs are due by December 31 but John may defer his first required minimum distributions to April 1, 2020. Even if deferred to April 1, 2020, John’s 2019 RMDs will be based on John’s Dec. 31, 2018 IRA and Plan balances;
4 John must also take RMDs for 2020 by Dec. 31, 2020 based on Dec. 31, 2019 balances;
5 John must take RMDs for 2021 and subsequent years by December 31 of each year based on balances as of December 31 of the prior year.