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RMDs From IRAs

distribution-centre-by-nick-saltmarsh1I’ve made the observation before – IRAs are like belly-buttons: just about everyone has one these days, and quite often they have more than one.

Wait a second, maybe they’re not quite like belly-buttons after all.

Oh well, you get the point – just about everyone has at least one IRA in their various retirement savings plans, and these accounts will eventually be subjected to Required Minimum Distributions (RMDs) when the owner of the account reaches age 70 1/2.

So what are RMDs, you might ask? When the IRA was developed, it was determined that there must be a requirement for the account owner to withdraw the funds that have been hidden from taxes over the lifetime of the account, in order for the IRS to begin benefiting by the taxes that are levied against the account withdrawals. A schedule was prepared which approximates the life span of the account owner.  This schedule prescribes a minimum amount to be withdrawn each year that the account owner is alive, until the account is exhausted.

A participant in a traditional IRA (Roth IRAs are not subject to RMD rules by the original owner) must begin receiving distributions from the IRA by April 1 of the year following the year that the participant reaches age 70 1/2. In other words, assuming that the participant reaches age 70 during the months of January through June of 2015,  the participant reaches age 70 1/2 during the 2015 calendar year.  Therefore RMD must be withdrawn by April 1, 2016. On the other hand, an individual who reaches age 70 during the latter half (July through December) of 2015 does not reach age 70 1/2 until the 2016 calendar year.  As such, RMD must be withdrawn by April 1, 2017.

After that first year’s RMD is withdrawn, the second year’s RMD must be taken by December 31 of the same year. In our examples above, the first participant must make a RMD withdrawal by April 1, 2016, and another by December 31, 2016. The second participant must make a RMD withdrawal by April 1, 2017 and another by December 31, 2017. For all subsequent years, the RMD must simply be withdrawn by December 31 in order to be credited for that year. If you don’t want to double up the distributions for your first and second RMDs, you can take the first RMD by December 31 of the year you reach age 70 1/2. By taking your first and second RMDs as originally described, you will be taxed on both distributions in that second year. This might result in adverse taxes to you.

Calculation of the RMD is fairly straightforward, although there is some math involved. For the first year of RMD, the participant could be age 70 or 71, depending on when the birthday falls. IRS determines your applicable age based on your age at the end of the year. According to the Uniform Lifetime Table (See IRS Publication 590 for more detail on other tables), the distribution period for a 70-year-old is 27.4, and 26.5 for a 71-year-old.

So if an individual participant has IRAs worth $100,000 at the end of the previous year and will be 70 at the end of the current year, dividing that balance of $100,000 by 27.4 produces the result of $3,649.64 – the RMD for that first year. For a 71-year-old, you would divide the $100,000 balance by 26.5 to render a RMD of $3,773.58.

Each subsequent year, you would take the balance of the accounts on December 31 of the previous year and divide by the distribution period from the Uniform Lifetime Table for your attained age for the current year, and make sure that you take a distribution of at least that amount during the calendar year.

Now, I made a point of indicating that you calculate your RMD based on the balance of all of your IRAs. This is because the IRS considers all of your traditional IRAs as one single account for the purpose of RMDs. You are required to take RMD withdrawals based on the overall total of all accounts. This withdrawal can be from one account, evenly from all accounts, or in whatever combination you wish as long as you meet the minimum distribution for all accounts that you own.

Another point that is extremely important to note: taking these distributions is a requirement. Failing to take the appropriate distribution will result in a penalty of 50% (yes, half!) of the RMD that was not taken. As you can see, it really pays to know how to take the proper RMD withdrawals – the IRS has very little sense of humor about it.

Understand that the examples I’ve given are for simple situations, involving the original owner of the account and no other complications. In the case of an inherited IRA or other complicating factors, or if the account is an employer’s qualified plan rather than an IRA, many other factors come into play that will change the circumstances considerably. If you need help on one of these more complicated situations, it probably would pay off in the long run to have a professional help you with the calculations.

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