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What You Need to Know About RMDs

The rules surrounding IRA Required Minimum Distributions (RMDs) are often confusing, and the tax penalty for failing to take the correct RMD can be severe. Therefore, it is important to understand these basic facts about RMDs.

What are RMDs?

RMDs are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age.

Retirement plan participants and IRA owners are responsible for taking the correct amount of RMDs on time every year from their accounts.

When do RMDs start?

You must take your first required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31. Delaying your first RMD would result in taking two distributions in a single year, which may impact your taxable income.

Example: Jane reached age 70½ on September 15, 2013. She must receive her 2013 RMD by April 1, 2014, based on her 2012 year-end balance. Jane must receive her 2014 RMD by December 31, 2014, based on her 2013 year-end balance.

If Jane receives her initial RMD for 2013 on April 1, 2014, then both her 2013 and 2014 distributions will be included in income on her 2014 income tax return.

To avoid having both of these amounts included in her income for the same year, Jane could have made her first withdrawal by December 31, 2013 (the year she turned 70½) instead of waiting until April 1 of the following year.

It is best to seek the advice of a tax professional to decide when is the right time to take your first RMD.

What accounts require RMDs?

You generally have to take an RMD from any retirement account to which you have made tax-deferred contributions or had tax-deferred earnings, e.g. an employer sponsored plan. These accounts include:

  • Traditional IRAs
  • SEP IRAs
  • SIMPLE IRAs
  • 401(k), 403(b) and 457 plans
  • Pension and profit sharing plans
  • Inherited beneficiary qualified accounts
  • Roth 401(k)

Roth IRAs are an exception. You are not required to take RMDs from a Roth IRA during your lifetime; however, beneficiaries will need to take an RMD after your death.

What if I don’t take my RMD?

If an account owner fails to withdraw an RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50% by the IRS.

How is your RMD calculated?

The RMDs for your retirement plans or IRAs are calculated by dividing the prior December 31st balance of each account by your life expectancy. Your life expectancy is estimated by the IRS under their particular life expectancy tables, which can be found on their website. As your life expectancy decreases, your RMDs begin to increase. For example, by the time you’re 90, your RMD will be about 10% of your account value.

RMDs are configured to distribute the entire interest of the retirement plan account or IRA over the life expectancy of the owner, or the life expectancies of the owner and his or her beneficiary. The function of this arrangement is to prevent people from avoiding taxes by simply building retirement savings tax-deferred and then leaving it all as inheritance. With the implementation of RMDs, the government is able to tax distributions from retirement funds over an owner’s lifetime.

If your spouse is 10 years younger and the sole beneficiary of your IRA, then you qualify to use the joint life and last survivor expectancy table, which lowers your RMD amount. Since your spouse is much younger, your joint life expectancy is then greater. This exception is to help support younger spouses by making the IRA last longer.

It is important to understand that there is more than one formula for taking the distribution so make sure you are choosing the correct life expectancy table, as there are three to choose from. One table is for account beneficiaries. A second table is for account holders whose spouse is 10 years younger and is the sole beneficiary. The last table is for account holders whose spouse is less than 10 years younger or if the spouse is not the beneficiary.

Who calculates my RMD payments?

Charles Schwab & Co., Inc. (“Schwab”) will calculate the RMD for each Traditional and Rollover IRA account that Portfolio Solutions® manages beginning in the year a client turns 70 ½ . Schwab prints the RMD amount on the respective monthly statement for each account. We ask that each client confirm the amount with their tax professional each year and also seek tax advice for any retirement accounts (IRAs or employer plan assets) that we do not manage. 

Please note that due to special rules surrounding Inherited IRA accounts, it is the client’s responsibility to work with their tax professional to determine the RMD for these types of accounts. Schwab does not calculate inherited IRA RMDs.

What happens after the account owner dies?

IRA beneficiaries must take distributions of the entire amount within five years of the owner’s death, or the beneficiary must take distributions over his or her lifetime beginning no later than one year after the owner’s death. A spouse has some additional options upon inheriting an IRA, and would benefit from the advice of a tax professional.

How are RMDs taxed?

RMDs are taxed as ordinary income. However, to the extent the RMD is a return of basis (such as  after-tax contributions) or is a qualified distribution from an inherited Roth IRA, it is tax free. While RMD amounts cannot be rolled over into another tax-deferred account, taxes on a distribution can be postponed until you file that year’s income-tax return.

What should I do with my RMD?

If your investment adviser provides monthly withdrawals from your accounts, then the total of those distributions from ‘designated’ accounts may be enough to cover your RMD. If not, your investment adviser can arrange the appropriate distribution, which presents a great time to also do your annual portfolio rebalancing. Either way, each year you should check with your financial and tax advisers to see if you’ve met your RMD withdrawal requirements or what additional amount you need to take.

In the case that you don’t need your RMD amount for living expenses, you have a variety of options for putting that money to use. One, it can easily be reinvested into a taxable account and potentially generate additional growth in your portfolio.

Or, since the funds have to be withdrawn anyways, they can go toward special lifestyle expenses such as a vacation or gifts for the family. As the oft-repeated Ben Franklin quote goes: “…in this world nothing can be said to be certain, except death and taxes.” The government will get the latter, so you may as well enjoy your money before the former.

How do I request RMDs with Portfolio Solutions®?

Portfolio Solutions® will work with clients to facilitate the RMD transfer for accounts we manage at Schwab. Our clients will also receive a reminder from us during the second half of the year to take their RMD from a managed account if a client has not done so already.

As always, we are happy to answer any investment management related questions as it relates to RMDs.  Please contact your Investment Specialist if you would like to know more about your RMDs.