50+ Lifestyles

It’s RMD Time Again!! – Avoid these 6 Common Errors

By Richard J. Schillig, CLU, ChFC, LUTCF
Independent Insurance and Financial Advisor

As a New Year begins and thoughts of income tax preparations are in the back of our minds, another tax item surfaces. Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty.

The RMD rules are calculated to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime. The government says – these retirement accounts have been income tax-deferred all during the accumulation period. At some point, these funds need to be taxed. That’s what the RMD rules are all about.

Because of the interest and the number of inquiries I receive regarding RMDs – I thought it appropriate to share with you these 6 commons errors….

#1 Not taking all retirement accounts subject to RMDs into account. Often we have several IRAs or retirement plans. Make sure you take all of those balanced into account for calculating RMDs. In addition, we may have inherited IRAs that are subject to RMDs. We need to have a complete inventory of accounts subject to RMDs. Remember there is a 50% penalty for not taking an RMD, although the penalty can be waived for a good reason by filing Form 5329 with IRS and explaining that the client made an honest mistake, was confused or ill, OR received incorrect information from the financial institution of advisor. The 50% penalty also applies to missed RMDs from inherited IRAs and Inherited Roth IRAs. Roth IRAs are not subject to the lifetime Required Minimum Distribution rules since no distributions are required during the lifetime of the owner. However, Roth IRAs are subject to Required Minimum Distributions rules after the death of the owner of the Roth IRA with a 50% penalty if such distributions are not made.

#2 Getting confused about first-year RMDs. First year RMDs are overwhelming for some people. The common error is using the wrong balance for the first RMD. Remember RMDs begin for the year a client reaches age 70 ½. Use the December 31st balance of the year prior to the first required distribution year, even if the actual first RMD is not taken in that year. For the first year, the law gives you until April 1st of the nest year to take the first RMD.

For example, if Jim turned 70 ½ at any time in 2017, his required beginning date is April 1 2018. If Jim elects to take his first RMD in March 2018, he still must use the Dec 31 2015 IRA balance to calculate his first year RMD, since that is the year-end balance before his 70 ½ year (2016).

#3 Committing aggregation errors. This occurs when you have multiple IRAs or company plans subject to RMDs. Make sure you take RMDs from the right plan or IRA. For example you cannot satisfy an IRA RMD from a 401K and vice versa. However, IRAs have a special aggregation rule that allows RMDs from IRAs (including SEP & SIMPLE IRAs) to be taken from any one or combination of those IRAs. 403b plans have the same aggregation rule. BUT you cannot satisfy a 403b RMD from an IRA and vice versa. You also cannot satisfy an IRA RMD from an inherited IRA.

Inherited IRAs received from the same person can be aggregated for calculating RMDs but RMDs for IRAs inherited from different people cannot be aggregated. They must be calculated and taken separately.

A husband and wife who each have IRAs subject to RMDs must take those RMDs separately from their own IRAs. For example a husband cannot satisfy his RMD from his wife’s IRA and vice-versa even though the total RMD for both will be reported on the same joint tax return.

#4 Still working exception mistakes. A special exception to RMDs applies to those who are still working for a company but this exception never applies to IRAs or to other plans of companies the person no longer works for. The exception allows persons to delay RMDs until the year after they retire. This exception only applies to the RMD from the plan of the company the employee is still working for. This exception also generally does not apply to self-employed persons with a company plan. This so called “still working’ exception does not define “still working” so it can apply even if the client worked only part time or for even a few days during the year.

#5 Not taking RMDs from inherited Roth IRAs. While there are no lifetime RMDs for a client’s own Roth IRA, INHERITED ROTH IRAs are subject to RMDs and to the 50% penalty still applies. Even though the amount of the RMD is income tax-free the penalty for not taking RMD applies.

#6 Taking year-of-death RMDs. The confusion here lies in who takes a year-of-death RMD for a client who died and did not take their entire RMD for that year. The beneficiary takes that RMD based on the amount the decedent would have been required to withdraw had he lived.

There is not a choice here. The RMD is not reported on the estate income tax return of the decedent (form 1041) or on the decedent’s final income tax return.

If a person died before his or her RBD there is no RMD for that year, even if the person turned age 70 ½ that year but died before April 1 of that year.

Richard J. Schillig, CLU, ChFC, LUTCF is an Independent Insurance and Financial Advisor with RJS and Associates, Inc. He can be reached at (563) 332-2200.