updated 12/23/19

A Comprehensive Guide to Required Minimum Distributions

Breaking News:  on December 20, 2019 the SECURE Act was signed into law. Among other provisions, this bill substantially impacts the rules surrounding Required Minimum Distributions. The new laws are summarized in red in each relevant section below. We have also crossed out rules that are no longer applicable under the new law. 

It’s the most wonderful time of year – holiday parties, the first winter snowfall, and…Required Minimum Distributions?

That’s right – don’t forget to include your annual Required Minimum Distribution (‘RMD’) on your holiday to-do list! Not sure what an RMD is or whether it pertains to you? Look no further, this blog is our gift to you!

What is a Required Minimum Distribution ('RMD')?

A “Required Minimum Distribution” generally refers to an IRS-mandated dollar amount that must be withdrawn from a retirement account, such as a Traditional IRA or 401(k), each year. RMDs do not apply to everyone, however. Generally, they become due after certain triggering criteria is met – the most popular of which is turning 72 (used to be 70 1/2 under the old laws).

Age is not the only consideration. Did you know that the type of retirement account, whether you are still working, and your relation to the account are all factors to determine whether RMDs apply?

The purpose of this blog is to review these four qualifying criteria in more detail, and to provide a basic outline on how to calculate an RMD.

Why does this rule exist?

Simple: taxes. Recall, investors are allowed to save and invest inside the above accounts without paying tax on earnings along the way. In exchange, tax is only due when money is withdrawn from the account – which ideally would be years, if not decades, down the road (i.e. in retirement). In finance jargon this is known as “pre-tax” or “tax-deferred” savings.

Tax-deferred is not the same as tax-free. The IRS does not let the party last forever (enter the Required Minimum Distribution rule). Without an RMD rule, retirees who don’t rely on IRA/401k assets to pay bills could otherwise let these pre-tax funds stockpile indefinitely. The IRS would never get a piece of the pie.

RMDs are not something to take lightly – an incorrect calculation or altogether forgotten distribution could result in a 50% penalty, one of the harshest penalties in the tax code.

How do I know if I need to take RMDs?

Generally there are four criteria which determine whether you are subject to RMDs (click on each to learn more):

1) Type of Account
RMDs should generally be on your radar if you have any of the following retirement accounts:
  • Traditional IRAs (not Roth IRAs)
  • SIMPLE IRAs
  • SEP IRAs
  • 401(k)s (includes Roth 401ks) – see #3 for exceptions
  • 403(b)s
  • TSPs
  • 457s
  • IRAs that you inherited (both Traditional and Roth) – see #4 for more details
2) Age
The SECURE Act has changed the age at which Required Minimum Distributions start. Under the new law, RMDs kick in once you turn 72. Note, however, that if you turned 70 1/2 in 2019 you are subject to the old laws mentioned below.

The magic number is 70 ½. That’s generally the age when Required Minimum Distributions start (see #3 for exceptions).

Your first RMD is not due the exact day you turn 70 ½. You actually have until April 1st of the following year to complete your first RMD. Every year thereafter, the Required Minimum Distribution must be withdrawn from your account by December 31st.

  • If your birthday is on or before June 30:   you turn 70 ½ within the same calendar year. You have until April 1st next year to take your first RMD.
  • If your birthday is on or after July 1:   you turn 70 ½ in the next calendar year. You have until April 1st of the year after next to take your first RMD (i.e. not next year, but the year after)
3) Employment Status
If you are still working and are not an owner of your company (or own less than 5% if you are an owner), you do not have to take an RMD from your workplace 401(k).

Note: working past 72 does not excuse you from taking required distributions from IRAs (Traditional, SEP, and SIMPLE) or from 401(k) accounts held with former employers.

4) Relation to the Account
Given the popularity of IRAs and 401(k)s, it is highly likely you will inherit one from a family member or friend in the future if you don’t already have one yourself.

Be aware that RMDs do not go away after someone dies. Generally, the person(s) who inherits the account will either start or continue to take RMDs (depending on their age and relationship to the deceased). Someone once said something about “death and taxes” being the only certainties in life. Perhaps RMDs should be added to the list!

The next section covers inherited retirement account RMDs in more detail. Side note: regardless of the heir’s relationship, if the original account owner was already taking RMDs and had not yet taken this year’s distribution before he/she died, the RMD needs to be removed from the account before the end of the year!

How to Calculate a Required Minimum Distribution

Calculating an RMD is relatively straightforward if it is your own account. It gets a little trickier if it’s an account you inherited from someone who died. Refer to the section “What do I do if I Inherit a Retirement Account?” to learn more. Pay attention because the 50% penalty for incorrect RMDs still applies whether it’s your own account or someone else’s!

You only need two numbers to calculate your RMD:

First, your account balance(s) as of December 31st of the previous year. For example, a 2019 RMD is based off the account balance as of 12/31/2018.

Second, use the IRS chart to the right to get your life expectancy factor. Use the number associated with how old you’ll be at the end of the year the RMD is due. Quick note – you need to use a different chart chart if your spouse is 10 years younger than you.

To figure your RMD, simply divide the prior year ending balance by this life expectancy factor. Easy as that – rinse and repeat each year.

how to calculate your rmd
Example

John’s birthday is 3/1/1944. He’s been taking RMDs since 2017, the year he turned 70 1/2.  This year he will be 75, so his RMD age factor is 22.90. His IRA balance as of 12/31/2018 was $500,000. Therefore his 2019 RMD is $21,834.06 (500,000 ÷ 22.90), which must be distributed no later than December 31st .

What if I have more than one IRA?

Many people have more than one Traditional IRA, or a combination of Traditional IRAs, SEP IRAs, and SIMPLE IRAs. These folks can simply withdraw their RMDs from each account separately, or they can pull the entire amount due from just one account (or cherry-pick from several). The latter might make sense if one IRA is invested in an illiquid asset, or if you’d just rather not take a distribution from a particular account.

For example, say you have three IRAs – one has an RMD of $5,000, the other has an RMD of $10,000, and the third has an RMD of $15,000. You could individually withdraw the RMD from each respective account, or you could withdraw $30,000 (the total amount due) from any one or two accounts. Ultimately the IRS is more concerned about the proper amount being withdrawn than from which account it is removed.

401ks cannot be aggregated – a separate RMD must be taken from each.

What do I do if I inherit a retirement account?

The IRS has one set of rules for those who inherit a retirement account(s) from a spouse, and another set for those who inherit a retirement account from anyone else (i.e. a parent, sibling, friend, cousin, etc.).

→ Inherited From Your Spouse

Those who inherit a retirement account from their spouse have the most flexibility. In general, the surviving spouse has four options:

Option 1: Transfer the funds to their own IRA (a "Spousal Rollover")
The first option for a surviving spouse is to assume ownership of the account and treat it as though it’s always been theirs (called a “Spousal Rollover IRA”).

If the survivor already has an IRA, he/she could transfer (“roll”) the deceased spouse’s IRA funds into their own account. If the survivor does not already have an IRA (or does not want to consolidate the funds), he/she can simply open a new IRA and roll the deceased spouse’s funds into a new account (called a “Spousal Rollover IRA”).

In this case RMDs are due once the surviving spouse turn 72 (because the funds are treated as though they belonged to the inheritor from the get-go). The calculation is done exactly the same as described in the above section (last year’s 12/31 ending balance divided by your IRS life expectancy factor). If the inheriting spouse already happens to be over 72, he/she just add these funds to their collective pot and continues taking a Required Minimum Distribution each year as per usual.

Option 2: Transfer the funds to an Inherited IRA
Instead of transferring the inherited retirement assets to their own IRA, a surviving spouse could also transfer the funds to an entirely new account called an Inherited IRA, or a beneficiary IRA. The funds are not co-mingled with the spouse’s own retirement funds.

What difference does it make? While this slight change in wording might not sound like a big deal, in practice it is anything but.

Spouses who choose to transfer their deceased spouse’s funds to an Inherited IRA are treated just like non-spouse inheritors for all intents and purposes. Refer to that section below for the specifics.

Usually it is more advantageous for a surviving spouse to roll the funds to their own IRA (option #1), but depending on his/her current age & income needs and/or the age gap between the spouses, it may make sense to do an Inherited IRA instead. What’s more, spouse inheritors also have the unique ability to “change their minds” and transfer spousal Inherited IRA funds to their own IRAs months or even years later should they so choose. Recall, the IRS charges a 10% penalty on most IRA distributions before the age of 59 1/2. This is not the case with Inherited IRAs, however. Thus, a surviving spouse under 59 1/2 would be able to avoid this penalty by keeping the funds in an Inherited IRA until they are over 59 1/2 , at which point the funds could then be transferred to their own IRA (to push off future Required Minimum Distributions until they turn 72).

Option 3: Liquidate
Of course, surviving spouses have the option to totally liquidate (i.e. close) inherited retirement accounts and take the cash. In other words, they cannot be forced to keep the funds inside of an IRA (either their own or an Inherited IRA).  The account can be liquidated in one fell-swoop, or over a 5 year period (it must be zeroed out by the end of Year 5).

Liquidation is usually not advisable, because the entire amount will be taxed all at once – leading to what could be a hefty tax bill. Electing to liquidate over a 5-year period may smooth out some of the tax brunt, but it will still likely lead to higher taxes than leaving it in an IRA and stretching out tax-deferral over your own lifetime. Liquidations may also inadvertently push you into a higher tax bracket and affect things as Medicare and capital gains rates.

Talk with a tax advisor to see how this would affect your specific situation.

Option 4: Disinherit
Surviving spouses also cannot be forced to actually take possession of the inherited retirement funds. In other words, the survivor could opt to have these assets pass directly to the next level of beneficiaries instead, such as children or grandchildren.

Why would anyone do this?

Perhaps the surviving spouse has substantial assets on their own (enough to pay the bills and live comfortably) and believes the next generation would benefit more from these funds. Ostensibly the younger generations would also have a longer time span to stretch these tax-deferred assets (and likely at lower tax brackets as well). It may also make sense if the couple’s combined estate is more than the estate tax limit (over $22 million), because disinheriting the account(s) would keep them from being included in their estate.

Consult your estate attorney or tax advisor to discuss this in more detail.

→ Inherited From Someone Who Was Not Your Spouse

There is generally less flexibility available to those who inherit a retirement account from a parent, sibling, aunt/uncle, or friend, etc. (i.e. anyone but their spouse). Thanks to the 2019 SECURE ACT, there is even less flexibility. Here are the three choices:

Option 1: Transfer the funds to an Inherited IRA
The SECURE Act requires assets within an Inherited IRA to be fully liquidated within 10 years (for most non-spouse recipients) and can no longer be “stretched” over the beneficiary’s lifetime. 

The beneficiary is not required to take an RMD each year – the account simply has to be empty by the end of Year 10. Certain non-spouse beneficiaries still have the option to “stretch” an Inherited IRA over their own lifetime, however (so they follow the “old” RMD rules discussed below). They are: those who are disabled or chronically ill, and minor children of the original owner, up until they reach the “age of majority” (which depends on your state). 

Keep in mind the new rules only apply to retirement accounts inherited starting in 2020.

If you already inherited a retirement account from someone before 2020 and transferred the funds to an Inherited IRA, you will continue to use the old set of rules. Continue reading below:

Unlike spouse heirs, non-spouse heirs cannot transfer inherited retirement assets to their own IRAs. Rather the funds can be transferred to a new IRA, called an Inherited IRA account. If you inherit retirement assets from more than one person, each pot of funds must be transferred to their own respective Inherited IRA (i.e. you cannot co-mingle retirement assets inherited from different people). You also are not able to make further contributions to the account.

To calculate your annual RMD simply take the prior year 12/31 balance and divide by the applicable IRS age factor. There are two noticeable differences, however.

First, non-spouse heirs use a different IRS chart – one called the “Single Life” table (see below). The factor is usually based on the heir’s age at the end of the year the RMD is due. However, if the heir was older than the person who died and that person was already over 70 1/2, the factor would be based on the deceased person’s age instead.

Second, instead of the inheritor using the chart to look up their age factor each year, they typically only need to use it once: for the very first RMD. This is the “base” factor. Each year going forward they simply subtract 1 from the prior year’s number.

how to calculate an RMD on a non-spouse inherited IRA

Example:

Bob was 39 when he inherited an IRA from an older sibling last year (2018). Bob has until December 31, 2019 to withdraw his first RMD. Because Bob will be 40 in 2019, his age factor from the IRS Single Life table is 43.60. The account was worth $100,000 as of 12/31/2018.  Therefore his first RMD is $2,293.58 ($100,000 ÷ 43.60), which, again, must be withdrawn anytime before 12/31/2019.

In 2020, Bob would calculate his next Required Minimum Distribution using the account balance as of 12/31/2019 and his age factor would be 42.60 (43.60 minus 1). He does not need to look up the factor for age 41 in the IRS chart. In 2021 his age factor would be 41.60 (42.60 minus 1). Rinse and repeat.

Option 2: Liquidate
The second option is to totally liquidate the account and take the proceeds in cash. In other words, the inheritor cannot be forced to move the funds to an Inherited IRA.  The account can be liquidated in one fell-swoop, or over a 5 year period (it must be zeroed out by the end of Year 5).

Liquidation is usually not advisable, because the entire amount will be taxed all at once – leading to what could be a hefty tax bill. Electing to liquidate over a 5-year period may smooth out some of the tax brunt, but it will still likely lead to higher taxes than leaving it in an Inherited IRA and stretching out tax-deferral over their own lifetime. Liquidations may also inadvertently push you into a higher tax bracket and affect things as Medicare and capital gains rates.

Talk with a tax advisor to see how this would affect your specific situation.

Option 3: Disinherit
The final option for a non-spouse inheritor is to disclaim or disinherit the assets. This means the funds skip over you and are passed straight to the original owner’s contingent (i.e. secondary) beneficiaries, such as another sibling or other relative.

Why would anyone do this?

Perhaps the intended heir has substantial assets on their own (enough to pay the bills and live comfortably) and believes the contingent beneficiaries would benefit more. Or, if the intended heir’s estate is already over the estate tax limit (over $11 million for a single person, and $22 million for a married couple), disinheriting these assets would keep them from being included in their estate.

Consult your estate attorney or tax advisor to discuss this in more detail.

Conclusion

It’s possible the IRS will update the tables used to calculate RMDs. These tables are based on average life expectancies, which have steadily increased since the tables were last revised in 2002. All things being equal, a larger life expectancy factor in the bottom-part of the RMD equation would make retirees’ required distributions smaller (and have less income to be taxed).

We hope you’ve found this to be a useful guide as you weigh how RMDs might impact your personal financial plan. Be sure to consult your legal, tax, and financial advisors on how RMDs may affect your personal situation.

Drop us a line at info@taylorhoffman.com if you’d like to learn more about Required Minimum Distributions!

Happy Holidays!

Disclosures1

1Taylor Hoffman is an SEC registered investment adviser with its principal place of business in the State of Virginia. Any references to the terms “registered investment adviser” or “registered,” do not imply that Taylor Hoffman or any person associated with Taylor Hoffman have achieved a certain level of skill or training. Taylor Hoffman may only transact business in those states in which it is registered /notice filed, or qualifies for an exemption or exclusion from registration /notice filing requirements. For information pertaining to the registration status of Taylor Hoffman or for additional information about Taylor Hoffman, including fees and services, please visit www.adviserinfo.sec.gov. The information contained herein is provided for informational purposes, represents only a summary of the topics discussed, and should not be construed as the provision of personalized investment advice or an offer to sell or the solicitation of any offer to buy any securities. The contents should also not be construed as tax or legal advice.  Rather, the contents including, without limitation, any forecasts and projections, simply reflect the opinions and views of the author. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change without notice. There is no guarantee that the views and opinions expressed herein will come to pass. This document contains information derived from third party sources.  Although we believe these third party sources to be reliable, Taylor Hoffman makes no representations as to the accuracy or completeness of any information derived from such third-party sources and takes no responsibility therefore. Taylor Hoffman is not a Public Accounting firm, and the information contained herein should not be construed as tax advice. Rather the contents included are a reflection of the view and opinions of the author. There is no guarantee that the information provided fits every situation, and individuals should consult their tax advisor for more specifics. Taylor Hoffman is not a law firm, and the information contained herein should not be construed as legal advice. Rather the contents included are a reflection of the view and opinions of the author. There is no guarantee that the information provided fits every situation, and individuals should consult their attorney for more specifics.