Aside from the pre-tax or tax-deferred environments, one of the fundamental differences between a Traditional and Roth IRA is whether or not you need to take a required minimum distribution (RMD). SEP, SIMPLE, and Traditional IRAs all require the account owners to start taking distributions from the account when they reach age 701/2
and continue taking yearly distributions going forward.
The first year you are required to take an RMD is when you reach age 701/2
, which is six months after your 70th
birthday. The IRS gives you until April 1 of the tax filing year to actually make the withdrawals. Subsequent RMD withdrawals, need to be completed by December 31 of each year.
Depending on when your birthday falls, distribution requirements can get confusing. For example:
Paul and Ernie have been lifelong best friends and opened Traditional IRAs back in their 20s. Thanks to careful saving, planning, and a healthy dose of good fortune, both men have only needed to take a few distributions from their IRAs since they turned 591/2 and could begin taking distributions penalty-free.
Paul’s 70th birthday was on May 28, 2014 and he will reach 701/2 on November 28, 2014. Since this is the first RMD for his account, he would have until April 1, 2015 (the tax filing year for 2014) to take the distribution. However, Ernie turns 70 on August 7, 2014 and it will be February 7, 2015 when he turns 701/2. Will he be required to start taking RMDs for the 2014 tax year? No. Ernie will have until April 1, 2016 (the tax filing year for 2015) to take his first RMD because he turned 701/2 in a new tax year (2015).
Is it possible you would be required to take two RMD withdrawals in one year? Yes. Since you have until April 1 of the following year for your first RMD, but are required to take subsequent distributions by December 31, you might have to take two RMDs in the same year. In the example above, if Paul waits until February 2015 to take his first RMD, this will satisfy the requirement for 2014, but he will still be required to take his 2015 RMD by December 31, 2015.
The same would be true for Ernie if he waits until April 2016 to take his first RMD. It’s also good to remember you can withdraw more than the RMD amount from your account as you see fit, but that ‘excess’ amount is not applied to the next year’s RMD. You also cannot roll your RMD amount into a Roth IRA or other tax-deferred account.
As for calculating the amount of your RMD, your IRA custodian will send you a letter every year with the RMD amount based on the value of your Traditional IRA with that custodian. The IRS provides
worksheets and tables if you prefer to calculate the amount yourself. If you have more than one Traditional IRA with one or more custodians, you might find it in your best interest to seek guidance from a tax advisor on the best way to take your distributions. For example, some individuals prefer to take an amount from each account with each custodian, while others might find it more beneficial to take the total amount from one account held at one custodian. As with all things, there are often a variety of options available and guidance from a qualified third party can be just the thing to stay on the right side of the IRS.
Facing the consequences
If you happen to forget to take your RMD or didn’t take the full amount by the deadline, the amount not taken is taxed at 50 percent. This would be reported on IRS Form 5329 and IRS Form 1040. You can find detailed instructions on the IRS website on how to figure out the excise tax you owe, but it might be in your best interest to seek guidance in this situation because you want to make sure you take the correct amount and that you are using the correct Form 1040. If you need to file Form 5329, you are not eligible to use Form 1040-A or 1040-EZ.
Paying the excise tax is the first step in correcting a mistake with your RMD. After you take care of the penalty amount, make sure you withdraw the full RMD amount you needed to take, as the excise tax is separate from the RMD balance from prior years. Make sure you fulfill your RMD obligation by December 31, for the current year as well! It is possible to request a waiver from the IRS for excise tax by providing a letter of explanation as to why you missed the RMD deadline. This letter is included with your tax return (Form 1040) and your Form 5329. Again, seeking guidance from a tax professional may be in your best interest in this type of situation, as the IRS can reject your request for the waiver.
It’s important to remember you have to take your RMD by the end of the year, but you do not need to wait until the end of the year to do so. The amount is based on your account value for the preceding year. This gives you the opportunity to request the distribution earlier in the year and have the peace of mind knowing this important item is complete.
Stay tuned in the coming weeks for RMDs part two: Dealing with RMDs if you only have illiquid assets in the account.