By: Denise Appleby, CISP, CRC, CRPS, CRSP, APA
Retirement account owners and beneficiaries may need to withdraw a minimum amount from their retirement accounts by December 31, in order to avoid owing an excise tax of 50% of the amount to the IRS. The determination of which retirement account owner is subject to this rule depends on the age of the retirement account owner. For beneficiaries, it depends on whether the retirement account owner died before the required beginning date (RBD) and the distribution options that are available to the beneficiary.
What Types of Accounts are Affected
The required minimum distribution (RMD)- also referred as minimum required distribution(MRD) -rules apply to owners and beneficiaries of traditional IRAs, SEP IRAs, SIMPLE IRAs, 403(b) accounts, governmental 457(b) accounts and qualified plan accounts such as 401(k) plans. For Roth IRAs, the RMD rules do not apply to owners, but they apply to beneficiaries.
Who is Affected
There are two categories of individuals who are affected; retirement account owners and beneficiaries.
Retirement Account owners
RMDs must be withdrawn from retirement accounts by account owners who are at least age 70½ this year. Exceptions apply to (a) 403(b) and 457(b) account and (b) individuals with assets in qualified plans-such as a 401(k)s plans – who are still working for the plan sponsor/employer, and the plan allows employees who have reached age 70½ to defer beginning the withdrawal of their RMDs until they retire.
Beneficiaries who inherit retirement accounts may need to withdraw a minimum amount from their inherited accounts by December 31. This determination depends on the following:
- If the retirement account owner died before the RBD, and the beneficiary is subject to the life expectancy rule: If a retirement account owner died before the RBD, the default provision under the tax code and for many plan documents and IRA agreements is that the beneficiary must distribute assets over his life expectancy. Under the life expectancy method, distributions are calculated using the life expectancy of the beneficiary. However, the beneficiary is instead subject to the five-year rule if:
- The plan document or IRA agreement does not offer the life expectancy option and requires that the beneficiary uses the five-year rule
- The plan document or IRA agreement implements the five-year rule as their default option, when the life-expectancy option available upon election, and the beneficiary fails to elect the life-expectancy option by the deadline. The deadline is usually stated in the plan document or IRA agreement, and is usually December 31 of the year that follows the year in which the participant dies but could be earlier.
- The beneficiary is a non-person, such as an estate or a charity
If the beneficiary is subject to the life expectancy rule, he must withdraw RMD amounts every year, beginning with the year that follows the year the retirement account owner died.
- If the retirement account owner died before the RBD, and the beneficiary is subject to the five-year rule and it is now the fifth year: Under the five year rule, withdrawals up to the 4th year are optional. However, the entire account balance must be withdrawn by December 31 of the 5th year.
- If the retirement account owner died on or after the RBD: If the retirement account owner died on or after the RBD, then RMDs must begin by December 31 of the year following the year of his death. In such a case, the life-expectancy method applies and this allows the beneficiary to use their life expectancy or what would have beeen the remaining life expectancy of the decedent, whichever is longer.
Required Beginning Date Defined
The RBD is the deadline by which the first RMD amount must be withdrawn from a retirement account. For Traditional IRAs, SEP IRAs and SIMPLE IRAs, the RBD is April 1 of the year that follows the year in which the individual reaches age 70½. Therefore, if the retirement account owner reaches age 70½ this year, his RBD is April 1 of next year.
Forowners of 403(b) accounts, 457(b) accounts, and individuals with assets in a qualified plan-such as a 401(k) – who are still working for the plan sponsor/employer, and the plan allows employees to defer beginning the withdrawal of their RMDs until they retire, the RBD is the later of (a) April 1 of the year following the year the employee reaches age 70½, or (b) April 1 of the year following the year the employee retires.
The Significance of the RBD
One can look at the RBD as an extension of time to get into the RMD groove, because the April 1 deadline is an extension of time to take the RMD that is due for the year for which the first RMD is due. For instance, if an IRA owner reaches age 70½ this year, an RMD amount is due for this year. However, unlike RMDs for subsequent years which must be withdrawn by December 31 of the year for which they are due, this years’ RMD need not be withdrawn until April 1 of next year. This allows retirement account owners who are new to the RMD requirements additional time to satisfy their first RMD.
Caution: If an RMD is due for this year and is deferred until next year , the individual will need to withdraw two RMD amounts during next year (the one for this year , and the one due for next year). The RMD is taxable in the year it is withdrawn, regardless of the year to which it applies. Therefore, if the RMD amounts are significant enough, it could put the individual in a higher tax bracket, resulting in higher income taxes on the RMD amount and any other taxable income received during the year.
Note: If the RBD falls on a weekend or public holiday, the RBD is the following business day.
The Excess Accumulation Penalty
The excess accumulation penalty applies to any portion of the RMD that is not withdrawn by the deadline. For instance, if the retirement account owner or beneficiary is required to withdraw an RMD amount of $1,000 by December 31 of this year and withdraws only $200, she will owe the IRS an excess accumulation penalty of $400 ($800 x 50%).
The excess accumulation penalty is reported on IRS Form 5329 on the individual’s tax return. For this year, the amount is calculated in Section Vlll of Form 5329 and line 60 of Form 1040 . Form 5329 includes a built in formula which helps the individual to calculate the amount of penalty that is due to the IRS.
Waiver of the Penalty
Individuals who feel they missed the deadline because of ‘reasonable error’ can request a waiver of the penalty, if they have taken steps (or are in the process of taking steps) to withdraw the RMD shortfall. In such cases, the individual would attach a statement of explanation to a completed IRS Form 5329. The penalty would not be paid unless the IRS notifies the individual that their waiver-request would not be honored.
The RMD deadline must be met even if the individual does not need the income. This can be frustrating for those who prefer to leave the amounts in their retirement accounts for their beneficiaries. For retirement account owners who do not want to continue withdrawing RMD amounts each year, the account can be converted to a Roth IRA if the Roth conversion eligibility requirements are satisfied.
If you are not affected by the RMD rules, you may know someone who is. Talk to your family members, relatives and friends who are at least age 70½ or who may have inherited a retirement account. They would very likely appreciate the fact that your assistance prevented them from owing the IRS the excess accumulation penalty.