The Ultimate Guide to Understanding Retirement Plan RMDs
How many times have you considered whether you should have an IRA (Individual Retirement Arrangement) and how best to make that happen?
For many Americans, this persistent question starts in their twenties and increases exponentially as time goes on. Maybe you’ve even sat down in front of the “Topics for Retirement Plans” section of the IRS website. Daunting, isn’t it?
Parsing through all the information available is time-consuming and fraught with suggestions containing barely visible ulterior motives, leaving the reader in desperate need of an alternative. This article will be the first in a comprehensive series on common customer concerns regarding IRAs and required minimum distributions (RMDs) aimed at doing just that.
Do Your Research on IRAs
The first thing that any reputable source will say is that you need to know what you need your IRA to do for you. The U.S. Securities and Exchange Commission provides a summary of investment best practices that includes a number of helpful links and tools, especially for those of us choosing new investments or investment professionals. Their advice essentially boils down to always do your own research and individualize your investment plan as much as possible based on your future and present needs.
Traditional vs Roth IRAs
Two of the most common types of IRAs are Traditional and Roth IRAs. Roth IRAs tend to be a little more flexible with withdrawals and distributions, but contributions to them are not tax deductible. Roth IRAs also have adjusted gross income maximums, so their relevance is limited to a smaller segment of taxpayers. The IRS provides a number of comprehensive documents on Roth IRAs, but a Roth only acquires RMD regulations if you are not the original owner.
|Features||Traditional IRA||Roth IRA|
|Who can contribute?||You can contribute if you (or your spouse if filing jointly) have taxable compensation, but not after you are age 70½ or older.||You can contribute at any age if you (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income is below certain amounts (see 2016 and 2017 limits).|
|Are my contributions deductible?||You can deduct your contributions if you qualify.||Your contributions aren’t deductible.|
|How much can I contribute?||The most you can contribute to all of your traditional and Roth IRAs is the smaller of: · $5,500 (for 2015 - 2017), or $6,500 if you’re age 50 or older by the end of the year; or · Your taxable compensation for the year.|
|What is the deadline to make contributions?||Your tax return filing deadline (not including extensions). For example, you can make 2016 IRA contributions until April 18, 2017.|
|When can I withdraw money?||You can withdraw money anytime.|
|Do I have to take required minimum distributions?||You must start taking distributions by April 1 following the year in which you turn age 70½ by Dec. 31 of later years.||Not required if you are the original owner.|
|Are my withdrawals and distributions taxable?||Any deductible contributions and earnings you withdraw or that are distributed from your traditional IRA are taxable. Also, if you are under age 59½ you may have to pay an additional 10 percent tax for early withdrawals unless you qualify for an exception.||None if it’s a qualified distribution (or a withdrawal that is a qualified distribution). Otherwise, part of the distribution or withdrawal may be taxable. If you are under age 59½, you may also have to pay an additional 10 percent tax for early withdrawals unless you qualify for an exception.|
Not Roth, So Which One?
For those of us who wish to be able to deduct our IRA contributions and avoid income restrictions, a “Not Roth” IRA is usually the answer. A quick search will show that IRAs can be set up with any financial institution, a stockbroker, life insurance company or mutual fund. That search, however, leads to quite a few more options.
There are at least a half dozen types of IRAs that are regulated by RMDs:
- Traditional IRAs — These are the most common type of IRAs, as described in the above chart.
- Simplified Employee Pension (SEP) IRAs, Simple 401(k) Plans & Simple IRAs — These plans are typically offered by an employer, but are also an interesting option for the self-employed.
- 403(b) Plans — Also known as a tax-sheltered annuity plan, this type of plan is available to 501(c)(3), public school, and cooperative hospital employees, and some ministers. For those of us working in the nonprofit world, these plans are often best.
- 457(b) Plans — These deferred compensation plans are available to select state or local government employees.
- Profit Sharing Plans — Another type of employer offered plan, profit sharing plans only receive contributions from the employer. They do not have a salary deferral feature, which differentiates them from a 401(k), and are among the most flexible IRA options. However, they also tend to have higher administrative costs.
- Other Defined Contribution Plans — These include Employee Stock Ownership Plans (ESOPs), Money Purchase Plans and a few others. Plans of this type are the most flexible, but like profit sharing plans, they will often have higher administrative costs.
Required Minimum Distributions (RMDs)
If you have any of these IRA types (or an inherited Roth IRA), it will be regulated by RMDs. These distributions typically begin when you turn 70½ or retire, and you will be required to withdrawal a specific amount annually from that date on. The IRS website also provides a chart detailing how many of the RMD regulations vary based on the type of IRA you intend to contribute to.
|Required Minimum Distributions for Account Owners|
|IRAs including SEP, SIMPLE and SARSEP IRAs||Defined Contribution Plans|
|When do I take my first RMD (the required beginning date)?||You must take your first RMD by April 1 of the year following the year in which you turn 70½, regardless of whether you are still employed.||April 1 of the year following the later of the year you turn 70½ or the year you retire (if allowed by your plan). If you are a 5 percent owner, you must start RMDs by April 1 of the year following the year you turn 70½.|
|When do I reach age 70½?||You reach age 70½ on the date that is six calendar months after the date of your 70th birthday. Example: Your 70th birthday was June 30, 2010. You reached age 70½ on December 30, 2010. You must take your first RMD (for 2010) by April 1, 2011. Example: Your 70th birthday was July 1, 2010. You reached age 70½ on January 1, 2011. You do not have an RMD for 2010. You must take your first RMD (for 2011) by April 1, 2012.||Same as IRA rule|
|What is the deadline for taking subsequent RMDs after the first RMD?||After the first RMD, you must take subsequent RMDs by December 31 of each year beginning with the calendar year containing your required beginning date. Example: You turn 70½ on July 15, 2010. You must take your first RMD, for 2010, by April 1, 2011. You must take your second RMD, for 2011, by December 31, 2011, and your third RMD, for 2012, by December 31, 2012.||Same as IRA rule|
|How do I calculate my RMD?||Your RMD is generally determined by dividing the adjusted market value of your IRAs as of December 31 of the preceding year by the distribution period that corresponds with your age in the Uniform Lifetime Table (Table III in IRS Publication 590-B, Distributions Individual Retirement Arrangements (IRAs)). If your spouse is your sole beneficiary and is more than 10 years younger than you, you will use the Joint Life and Last Survivor Expectancy Table (Table II in IRS Publication 590-B). Required Minimum Distribution Worksheets||Same as IRA rule Your plan sponsor/administrator should calculate the RMD for you.|
|How should I take my RMDs if I have multiple accounts?||If you have more than one IRA, you must calculate the RMD for each IRA separately each year. However, you may aggregate your RMD amounts for all of your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA.||If you have more than one defined contribution plan, you must calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan. Exception: If you have more than one 403(b) tax-sheltered annuity account, you can total the RMDs and then take them from any one (or more) of the tax-sheltered annuities.|
|May I withdraw more than the RMD?||Yes, an IRA owner can always withdraw more than the RMD. You cannot apply excess withdrawals toward future years’ RMDs.||Same as IRA rule|
|May I take more than one withdrawal in a year to meet my RMD?||You may withdraw your annual RMD in any number of distributions throughout the year, as long as you withdraw the total annual minimum amount by Dec. 31 (or April 1 if it is for your first RMD).||Same as IRA rule|
|What happens if I do not take the RMD?||If the distributions to you in any year are less than the RMD for that year, you are subject to an additional tax equal to 50 percent of the undistributed RMD.||Same as IRA rule|
Calculating Your RMDs
Calculating what your RMDs will be is a very individual process. It is based on your age and the balance of your IRA the year before you begin minimum distributions. If your spouse is more than ten years younger than you and is the sole beneficiary of your IRA, the worksheet for calculating your RMD can be found on the IRS website. The formula used for all other situations is similar, but simpler. Your RMD can be calculated by dividing your IRA balance on Dec. 31 the year prior to reaching the age requirement by the number designated by your age on the IRS’s RMD chart. You will need to repeat this process if you have more than one of these types of IRA. If you are not the original owner of the IRA, there is a similar age based chart in the appendices of the IRS publication on RMDs.
Flexibility versus Complication
As you continue down the path of selecting the right type of IRA for your individual needs, you will find a very simple truth. IRAs come in all types, but the more flexible the regulations governing the plan, the more calculation and research you’ll have to do. When choosing an IRA, the more flexibility you have with contributions and RMDs, the more complicated the process will be.