Required Minimum Distributions, Do I Need To Worry?

42662377 - homemade banana bread sliced on a table close-up. horizontal, rustic style Last week was a long week. In Jeff’s endless pursuit of physical fitness (not really), he hurt himself. All of us in the office tell him he will be fine, but the poor guy had to take it easy for quite a few days. Both of our schedules were a bit thrown off as a result, so we decided to revisit a topic for this week’s column that we covered a couple of years ago, Required Minimum Distributions.
As I sit in my kitchen writing this article, I have a loaf of banana bread in the oven. I have been baking banana bread for my kids since they were babies. It is a bit time-consuming, but they expect me to make it every once in a while and are always pleasantly surprised when they open the door and smell it baking in the oven. I love to see the looks on their faces when they come home to that wonderful aroma. I mention this because oddly enough, I can see a parallel between the topic of this week’s column and the banana bread I am making.
So, you may ask, how does banana bread remind me of required minimum distributions? First, let me give you some information on what they are and who needs to take them.
As the name suggests, a required minimum distribution, or RMD, is a yearly distribution that must be taken from certain types of tax-deferred retirement accounts. The minimum amount required to be taken, generally, is based on both the December 31 account value from the year prior and the appropriate life expectancy factor, which can be found in one of the life expectancy tables on the IRS’s website. The distribution is calculated by dividing the year-end value by the applicable life expectancy factor of the account owner.
Typically, people must begin taking their RMDs by April 1 of the year after they reach age 70 1⁄2 or retire, whichever is later. However, if the retirement account is an IRA or the person is a 5 percent owner of the employer sponsoring the plan, the account owner must take his or her first RMD at age 70 1⁄2, regardless of whether he or she is still working. Every year thereafter, an RMD must be taken by year’s-end, December 31.
However, those who decide to wait until April of the year after they turn 70 1⁄2 will need to take two RMDs in the same calendar year. This is because the second RMD would need to be taken by the end of that same year. We always suggest that people estimate their projected taxable income because by taking two RMDs in one year, they may be pushed into a higher tax bracket, thereby resulting in an unfavorable tax consequence. If that is the case, a person should consider taking the first and second RMD in separate tax years.
Another factor to consider with respect to RMDs is how to take them. Required minimum distributions from IRAs are calculated by using the year-end total of all of an individual’s IRAs, including SEP and SIMPLE IRAs. However, the entire distribution can be taken from any one or a combination of the IRA accounts.
But beware of potential traps to avoid. Spouses must calculate their own RMDs separately. Each spouse must take his or her RMD from his or her own IRA account(s). Also, should a person own an inherited IRA, as well as their own, then generally, distributions must be taken from each and may be required before the inherited IRA owner turns 70 1⁄2. However, RMDs from inherited accounts can be combined when they are each inherited from the same original IRA account owner.
Usually, distributions from employer plans, such as 401(k)s, also must be calculated on each plan and withdrawn separately from each one. Employer plans cannot be aggregated, with one exception, 403(b) accounts can be aggregated using the same rules for IRAs as noted above. The combined RMDs can be taken from any one or a combination of multiple 403(b) accounts.
An RMD from one type of plan be satisfied with a distribution from a different type of plan. In other words, a 403(b) RMD cannot be taken from an IRA. Likewise, an IRA RMD cannot be taken from a 401(k), or any other type of plan other than an IRA.
Generally, there are no required minimum distributions for Roth IRAs. However, an inherited Roth IRA does have one, as does a Roth 401(k) if the account owner is no longer working.
It is important to understand that there is a 50 percent penalty on any amount of RMD that should be taken and is not taken. Furthermore, if the RMD is taken out of the wrong type of account, it is treated as though it was not taken at all.
So, you may still be asking why RMDs remind me of that banana bread I am baking.
Well, many people are caught off-guard when they receive a notice from their custodian, saying they need to take an RMD. They have been trained to accumulate and not touch their retirement accounts during their working years (at least, that’s what we aim for). For some, that first RMD can be a bit of a concern. In fact, we meet with many people who are worried about “doing it correctly” and ask if they actually need to start taking them. Jeff and I tell them, as I will tell you, Cutter Family Finance readers, with those limited exceptions outlined above, you cannot avoid taking them. That being said, this should not be a source of worry for anyone.
Your financial professional or the custodian of your retirement accounts should be able to answer any questions you have and should be able to help you through the process. Furthermore, as we tell many clients, there is no requirement that they spend their RMD. Some use their RMDs to pay off bills, others use it as “fun money” and still others, who do not need it, choose to reinvest that money into a taxable account.
So, rather than worrying when you receive notice that you need to take an RMD, consider it a pleasant surprise—one that you will experience every year. Or think of it this way: you spend many years gathering the ingredients, mixing the batter and baking the bread. Now it’s time to enjoy the results.
As Jeff always says, be vigilant and stay alert, because you deserve more. He should be back next week.
Have a great week!