Beyond the Basics of RMDs
presented by Rich LeBranti
While the basic concepts of required distributions from retirement plans and IRAs are widely known, there are many aspects of the process that may not be fully understood.
Many retirees understand the age requirement of 72, that distributions are based on life expectancy, and accounts like Roth IRAs do not require RMDs. The penalty for not taking distributions is also well telegraphed.
Given the various rules governing RMDs, however, delving into the details often exposes how complex the process is. In addition, these rules are becoming more complicated with recent retirement law changes (i.e., SECURE Act) and other proposed regulations.
How the basic calculation works.
Here are five things about RMDs that may not be broadly understood and could surprise some retirees.
- RMDs can be delayed past age 72
- Known as the “still working exception,” this provision only applies to qualified retirement plans, not IRAs
- Beware of Roth holdings in a workplace retirement plan – RMDs ARE required
- Due to a quirk in the tax code, while required distributions are not required for Roth IRA owners, those holding designated Roth accounts (i.e., Roth 401(k)) in their retirement plan at work are subject to RMDs at age 72. That is unless the still-working exception applies
- Those with designated Roth accounts may consider a rollover of those funds from their retirement plans at work to an IRA before age 72 in order to avoid required distributions
- There are several IRS life expectancy tables, as well as different calculation methods depending on the circumstances
As part of the calculation, account owners and spousal beneficiaries will generally recalculate life expectancy each year, while calculations for non-spouse beneficiaries are non-recalculated.
Recalculation means that the life expectancy table is referred to each year to determine the life expectancy factor (divisor) for calculating the RMD. For example, in 2022, the life expectancy factor from the uniform table for a 72-year-old account owner is 27.4. For next year, the factor decreases to 26.5. For each year, the individual must refer to the IRS table for the figure.
Non-recalculation means that the individual only refers to the IRS life expectancy table once. For subsequent years’ distributions, the individual would subtract one each year and use that figure as the divisor for the RMD calculation.
For example, the life expectancy factor for a non-spouse beneficiary at age 50 is 36.2. If annual distributions are required, then the beneficiary would use 36.2 as the divisor for the first distribution and subtract one each year for subsequent distributions. Of course, other factors, such as the “10-year rule” may apply. Overall, recalculating life expectancy each year is more favorable since it will result in a lower required distribution.
- Heirs can donate RMDs to a charity, too
- Qualified charitable distributions (QCDs) allow account owners over the age of 70½ to distribute from an IRA tax free if conditions are met. This can include the RMD amount.
- Beneficiaries inheriting IRAs are also able to utilize the QCD option as long as the age 70½ requirement has been met
- There may be relief from the penalty for missing an RMD
- There is a steep penalty — 50% — for not taking RMDs
- However, many may not be aware that there is a process to rectify the situation and potentially avoid a high penalty
- First, the individual should calculate the missed distribution(s) and take corrective action by distributing that amount as soon as possible once the mistake is realized
- Then, complete IRS form 5329 – specifically the last section of the form (Part IX, Additional Tax on Excess Accumulation in Qualified Retirement Plans (including IRAs) – to correct the situation (https://www.irs.gov/forms-pubs/about-form-5329)
- With completed form 5329, attach a statement requesting a waiver of the 50% penalty. The statement should include why the RMD was missed, year(s) when it was missed, the amount of the missed RMD, and date when the mistake was realized. It should also include a statement that corrective action has been taken and when
- In general, as long as it was an honest mistake and a good faith effort has been made to correct the situation, the IRS has been reasonable in waiving the 50% penalty
Staying on top of the rules is important
RMDs will impact most retirees. While planning for distributions is part of a comprehensive financial plan, regulations change over time. It's important to stay up to date to avoid penalties. For more information on required distribution see IRS publication 590-B.
By Bill Cass, CFP®, CPWA®