Aside from the different tax environments, whether or not you need to take a required minimum distribution (RMD) is one of the fundamental differences between a Traditional and Roth IRA. Unlike a Roth IRA, SEP, SIMPLE, and Traditional IRAs all require the account owners to begin taking distributions from the account when they reach age 70 ½ and continue taking these annual distributions for as long as you hold the account.
Understanding the RMD Schedule
The first required minimum distribution from a Traditional, SEP, or SIMPLE IRA occurs when you reach age 70 ½, which is six months after your 70th birthday. The IRS gives you until April 1 of the year following the calendar year in which you reach age 70 ½ to make the first withdrawal. Going forward, your RMD must be withdrawn by December 31 of each calendar year.
Depending on when your birthday falls, distribution requirements can get confusing. For example:
Lucille and her husband Milo each own Traditional IRAs. Thanks to careful saving, planning, and a healthy dose of good fortune, they’ve taken a few distributions from their IRAs since they turned 59 ½ and those distributions were penalty-free.
Milo’s 70th birthday was on June 6, 2015 and he will reach 70 ½ on December 6, 2015. Since this is the first RMD for his account, he would have until April 1, 2016 (the tax filing year for 2015) to take the distribution. However, Lucille turns 70 on September 23, 2015 and it will be March 23, 2016 when she turns 70 ½. Will she be required to start taking RMDs for the 2015 tax year? No. Lucille will have until April 1, 2017 (the tax filing year for 2016) to take her first RMD because she turned 70 ½ in a new tax year (2016).
It is possible to be required to take two RMD withdrawals in one year. 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 could find yourself taking two RMDs in the same year. In the example above, if Milo waits until February 2016 to take his first RMD, this will satisfy the requirement for 2015, but he will still be required to take his 2016 RMD by December 31, 2016. The same would be true for Lucille if she waits until April 2017 to take her first RMD.
When it comes to 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 IRA with that custodian.
If you prefer to calculate the amount yourself, the IRS provides worksheets and tables.
If you have more than one 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.
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 nor can you roll your RMD amount into a Roth IRA or other tax-deferred account. As with all things, there are often a variety of options available and it is in your best interest to seek guidance from a qualified third party.
Handling Illiquid Assets
Satisfying your RMD is pretty straightforward when your account holds cash or easily liquidated assets such as stocks. If your IRA’s value is primarily in alternative assets, such as real estate or promissory notes, you might be faced with a new challenge as those assets are illiquid. Remember, if you hold more than one IRA, you will receive an RMD notice from each custodian but you do not have to withdraw funds from each account. For example, if you have two IRAs, one with illiquid alternative assets and one with cash and/or traditional assets, you can take the combined RMD from one account.
You still need to meet your RMD requirements – even if you do not have enough or any cash left in your IRA, but your account holds assets with value. If you find yourself in this position, reaching out to a qualified tax advisor can be in your best interest to review your options, especially if you are strongly considering doing nothing and dealing with the penalties at a later date. This is one of the reasons addressing your RMD as early in the year as possible can be to your advantage. When your account holds an asset such as real estate, your options may center on either:
Selling the asset and taking the RMD from the cash proceeds of the sale
Taking the asset or a portion of the asset as the taxable distribution and holding the asset personally going forward
A qualified advisor can review the aspects of each option to help you make the best decision possible. If you find you will distribute a portion of the asset personally, there is a process you need to follow to make sure the asset’s value is up to date and you have the asset re-titled to reflect the change of ownership. You also need to contact your IRA Custodian to determine which internal forms are needed to facilitate the distribution, revaluation, or sale of the asset – depending on the direction you take to address the situation.
What could happen if you don’t take your RMD?
If you neglect 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 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, be 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 to 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 situation.
Remember you must 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.