As we approach the holiday season, we prepare to enter what is undoubtedly the busiest part of the year for the majority of us. Between coordinating schedules with loved ones, shopping for gifts, and scrambling to get holiday meals together, it can be easy to let other important considerations slip our minds. One such consideration, for people of a certain age, is taking the Required Minimum Distribution from their retirement accounts.
In this entry, we’ll share everything you need to know about Required Minimum Distributions, so you can focus on what really matters with some peace of mind—and avoid potential tax penalties!
Note: The criteria outlined in this blog entry apply to the original owners of IRAs and other retirement accounts. This entry does not address required distributions for Inherited IRAs or Stretch IRAs.
What is a Required Minimum Distribution?
Federal law requires that owners of certain retirement accounts make an annual withdrawal. Generally speaking, if you own an IRA, SEP, SIMPLE IRA, 401(k), or other retirement account, you must begin taking the Required Minimum Distribution beginning at age 72. There is some nuance to the age requirement, so be sure to keep reading to determine whether the Required Minimum Distribution applies to you and your plan.
An exception to this general rule applies to owners of Roth IRAs, which do not require withdrawals until after the death of the original owner.
The withdrawal is included in your taxable income, with the exception of any portion which has already been subject to tax (basis) or which can be received tax-free, such as qualified distributions from designated Roth IRAs. You are permitted to withdraw more than the minimum amount, if you so choose.
An important note: you are responsible for taking the correct amount of a Required Minimum Distribution on time. There is no obligation on your financial advisor or financial institution to do so for you. Those subject to a Required Minimum Distribution who fail to take the correct minimum amount on time may face steep penalties for their failure to do so, including up to a 50% tax on the amount of the Required Minimum Distribution which was not withdrawn.
Who is Required to Take the Minimum Distribution?
Probably the most confusing aspect to the Required Minimum Distribution is determining whether you are required to take it. Essentially, you will need to determine when you are required to make your first such withdrawal; thereafter, you will simply take the withdrawal on an annual basis by December 31 of each calendar year.
When you must take your first required withdrawal depends on the type of account you own:
If you were born before July 1, 1949, you must make your first withdrawal by April 1 of the year following the calendar year in which you reach the age of 70 ½ (defined as the date that is six months after your 70th birthday).If you were born after June 30, 1949, you must make your first withdrawal by April 1 of the year following the calendar year in which you reach the age of 72.Remember that the original owners of Roth IRAs are not required to make any withdrawals during their lifetime, though beneficiaries of those plans may be required to.
- 401(k), 403(b), Profit Sharing, or Other Defined Contribution Plans
The rules for these types of plans vary a little from IRAs. As with IRAs, if you were born before July 1, 1949, you must make your first withdrawal by April 1 of the year following the calendar year in which you reach the age of 70 ½ (defined as the date that is six months after your 70th birthday).If you were born after June 30, 1949, you must make your first withdrawal by April 1 of the year following the calendar year in which you reach the age of 72.However, depending on your plan, you may be able to defer withdrawals until April 1 of the year following the calendar year in which you retire. You will need to confirm that the terms of your individual plan permit this.
- The 5% Rule
Another nuance to the rules governing the Required Minimum Distribution concerns those who own businesses. No matter which type of plan, you must begin receiving distributions by April 1 of the year after the calendar year in which you reach age 70 ½ (or age 72 as described above) if you own more than 5% of the business sponsoring the plan, even if you have not retired.
When Must You Take the Required Minimum Distribution?
As mentioned above, you are required to take annual Required Minimum Distributions by December 31 of each year following your first required distribution.
One option you may consider is taking your initial Required Minimum Distribution by December 31 of the calendar year in which you reach the required age for beginning distributions (see above) rather than waiting until April 1 of the following year. This allows the distributions to be included in your income during two separate tax years, rather than receiving two distributions in one year.
How is the Minimum Distribution Calculated?
The Required Minimum Distribution for each year will vary based on two primary factors: the balance of your account(s) and your life expectancy. Thus, the amount of your Required Minimum Distribution will likely vary each year.
Generally speaking, the amount of the Required Minimum Distribution is determined by dividing the balance of the account on the prior December 31 by a life expectancy factor published by the IRS. The life expectancy table to be used varies based on your situation. Click here to review the IRS Tables in Publication 590-B, Distributions from Individual Retirement Arrangements.
If you have multiple accounts to which the Required Minimum Distribution rules apply, you have some flexibility in how you take your annual distribution. The Required Minimum Distribution is calculated on a per-account basis, the sum of which is your total Required Minimum Distribution that you must take for that year. However, once the total Required Minimum Distribution is determined, you may take that amount out of a single account or a combination of accounts. There is no requirement that you take the Required Minimum Distribution from each account on a pro rata basis.
The Effect of the CARES Act on Required Minimum Distributions
The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 suspended Required Minimum Distributions for the year of 2020. Anyone who opted to forego the Required Minimum Distribution in 2020 must now resume taking their Required Minimum Distribution.
Individuals who were born prior to July 1, 1949, reached the age of 70 ½ in 2019 and, therefore, became subject to the Required Minimum Distribution rules beginning in 2020. If you were originally scheduled to take your initial distribution in 2020 and chose not to (in accordance with the CARES Act), you must make your initial distribution beginning in 2021. A special rule under the Act allows those who opted against the initial distribution in 2020 to choose between taking one distribution in 2021 and one in 2022 or taking two distributions in 2022. If you choose to take one in 2021 and one in 2022, you must take that distribution by December 31 of each year. If you choose to delay your 2021 distribution and take two in 2022, you must take the first distribution by April 1, 2022. No matter when you choose to take that first distribution, that distribution will be based on the value of your account(s) on December 31, 2020.
Determining whether you are required to take a minimum distribution, and what that amount might be, is not something to take lightly, especially considering the hefty penalty for taking less than the required amount. We recommend that you consult your financial advisor or CPA prior to making your distribution.