Preparing For Retirement Plan RMD Season

By Denise Appleby AAA

The IRS has proved Ben Franklin right: paying taxes is inevitable - certainly when it comes to your retirement assets. You can defer paying income tax on tax-deferred retirement assets by refraining from taking distributions, but you can't do this indefinitely. The IRS requires you to begin receiving required minimum distributions (RMD) in the year you reach age 70.5, and an understanding of these requirements could help you avoid IRS penalties.

Affected Retirement Accounts
For retirement account owners, the RMD rules apply to Traditional, SEP and SIMPLE IRAs, qualified plans , 403(b) and governmental 457(b) accounts. For the purposes of this article, the term Traditional IRA will include also SEP and SIMPLE IRAs. The RMD rules do not apply to Roth IRA owners, but they do apply to Roth IRA beneficiaries, which we discuss in part 2 of this series.

When You Must Begin
Generally, your first RMD is due for the year you reach age 70.5. However, you need not start receiving distributions from your retirement account until your required beginning date (RBD). Generally, your RBD is April 1 of the year following the year you reach age 70.5. If you are still employed at age 70.5 and you participate in a qualified plan, 403(b) governmental 457(b) account, you may be allowed to defer the start of your RMDs until after you retire. This exception, however, does not apply if you own at least 5% of the business that adopted the plan. Your plan administrator should be able to tell you if the plan allows this deferment.

Age 70.5 Determination
Determining when you reach age 70.5 is as important as it is easy. The RMD regulations explain that you reach age 70.5 six months after the 70th anniversary of your birth. For example, if your date of birth is June 30, 1943, the 70th anniversary of your birth date is June 30, 2013, and you reach age 70.5 on December 30, 2013. Since you reach age 70.5 during 2013, your first RMD must be distributed by April 1, 2014. If you reach age 70 between July 1, 2013, and December 31, 2013, then you become 70.5 during 2014, and your RBD is April 1, 2015.

Example 1
Jack and Jill both own IRAs. Jack was born on June 30, 1943. Jill was born on July 1, 1943. They both reach age 70 in 2013 but 70.5 in different years: Jack reaches 70.5 on December 30, 2013, and Jill on January 1, 2014. Jack must therefore begin his RMD by April 1, 2014, while Jill may wait until April 1, 2015.

Subsequent RMDs
Only the first RMD may be delayed until April 1 of the following year. All subsequent RMDs must be distributed by December 31 of the year to which it applies. If in the above example Jack took his 2013 RMD on April 1, 2014, he would also be required to take his 2014 RMD by December 31, 2014. This means that Jack would have had to include both RMDs in his income for 2014, the year in which the distributions occurred.

Calculating Your RMD Amount
If you participate in a qualified plan, your plan administrator will assist you by calculating your RMD amount. If you are a Traditional IRA owner, your IRA custodian must notify you when an RMD is due from your account for the year, and is also required to either provide you with the calculated RMD amount or offer to calculate the amount upon request. Should you need to determine your RMD amount on your own, you may use the following formula:

IRA's previous year-end fair market value (FMV) / distribution period

Previous Year\'s FMV
Your IRA custodian should send you the previous year\'s FMV of your IRA by January 31 of the year following the current year. Therefore, your 2012 FMV must be mailed to you by January 31, 2013. However, the amount reflected on your FMV statement may be incorrect if the following occurred:
  • You received a distribution during the previous year and rolled it over during the current year. (It is possible to distribute an amount on December 31 and roll over the amount in February of the next year.)
  • You converted an amount to a Roth IRA during the previous year and recharacterized the amount during the current year.

If any of these situations exists, you must add the rollover or recharacterized amounts to the FMV you receive from your IRA custodian to determine the correct RMD amount.
Distribution Period
Your distribution period (or life-expectancy factor) is based on IRS-issued tables, which factor-in your age, your beneficiary\'s age, and your relationship (spouse or non-spouse) with your beneficiary. There are three tables (all three of which you can find in Appendix C of IRS Publication 590):

  • "Single Life Expectancy"
  • "Joint Life and Last Survivor Expectancy"
  • "Uniform Lifetime"

For purposes of calculating your RMD amount, only "Joint Life and Last Survivor Expectancy" and the "Uniform Lifetime" may be used. The "Joint Life and Last Survivor Expectancy" is used if you have a spouse beneficiary who is more than 10 years younger than you. In all other cases, the "Uniform Lifetime" must be used. (For more insight, see Life Expectancy: It\'s More Than Just A Number.)

Example 2
John is 73 years old this year. John\'s beneficiary is his spouse, Janet, who is 50. Since Janet is John\'s spouse and more than 10 years younger than him, John may use the "Joint Life and Last Survivor Expectancy" table to calculate his RMD. Based on the tables, John and Janet\'s joint life expectancy is 34.8 years - see the table below, which demonstrates how to find this number. John\'s year-end FMV for last year is $158,225, so his RMD amount for this year is $4,547 ($158,225 / 34.8 = $4,547).
Source: http://www.irs.gov/pub/irs-pdf/p590.pdf
Example 3
The facts are the same as in Example 2 except that Janet is age 72. Since Janet is not more than 10 years younger than John, he must use the "Uniform Lifetime" table to calculate his RMD. Based on this table, John\'s distribution period is 24.7 years - see the table below, which demonstrates how to find this number. John\'s RMD amount for this year is $6,406 ($158,225 / 24.7 = $6,406).
Source: http://www.irs.gov/pub/irs-pdf/p590.pdf

Penalty for Failure to Take RMD
As we mentioned earlier, your first RMD is due by April 1 of the year following the year you reach age 70.5. All subsequent RMDs must be taken by December 31 of each applicable year. If you fail to take the RMD by the applicable deadline, you will owe the IRS a 50% excise tax on the amount you fail to take. For instance, if your RMD this year is $10,000 and you distribute only $5,000 by the applicable deadline, you will owe the IRS $2,500 (50% of $5,000).

Request for Reprieve
If you feel the failure to take the RMD amount by the deadline is due to a reasonable error, you may write to the IRS and attach your letter to the Form 5329. If the IRS denies your request, you will be notified in writing and receive information about how you should remit the penalty amount.

Conclusion
As you can see, it's important to understand the IRS requirements on when you must start taking distributions from your retirement account. To avoid any penalties, you need to determine the date on which you reach age 70.5 and the amount of your RMD. There are, however, some further rules that could affect your RMD amount, which we discuss in part 2.

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