You might start by asking, “What’s an RMD?” RMD stands for Required Minimum Distribution and refers to the amount that traditional, SEP or SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts by April 1st following the year they reach age 70.5.
Let’s look at a quick hypothetical case study: take “Bob” who was born on June 1, 1946. He recently turned 70.5 years old in December, 2017. He has one Traditional IRA, one Traditional Rollover IRA, and a Roth IRA. He also has a small 401(k) from his semi-retirement gig, where he is still working as an employee. We will look at four key parts of an RMD for his situation: timing, aggregation, amount and rollovers.
Timing: The beginning date (LINK: https://www.irs.gov/retirement-plans/rmd-comparison-chart-iras-vs-defined-contribution-plans) on RMDs is generally by April 1st of the calendar year following the year in which the owner turns 70.5. This applies only to pre-tax qualified accounts. This does not apply to Roth IRAs. The exception to this start date is for employer-sponsored qualified plans, for a company of which you are less than a 5% owner and at which are still employed. The beginning date in this case, and in Bob’s case above in relation to his 401(k), is April 1st of the calendar year following the year of his retirement or separation from service. He is still required to take his first distributions from his Traditional IRA and Rollover IRA by the April 1, 2018 deadline. Future RMDs must be taken by 12/31 of each subsequent year.
Aggregation: The Traditional IRAs (including contributory and rollover) can be aggregated for purposes of determining the distribution amount and the RMD can be taken from either IRA or both depending on preference. If there are multiple IRAs, as in Bob’s case, he could work with his advisor to strategically invest the two IRAs so as to only have to take distributions from one and stay on track to meet his goals. Simple and SEP IRAs are also eligible to be aggregated with other IRAs in this way. Employer-sponsored qualified plans like 401(k)s, 403(b)s and 457(b) plans unfortunately cannot be aggregated for this purpose.
Amount: The amount used to calculate an RMD can be a little confusing as it’s based on the value of the account(s) on 12/31 of the previous year. Take Bob’s case. He turned 70.5 on 2017. His first RMD from his IRAs will be based on the balance of his Traditional and Rollover IRA at the close of business on the last business day of 2016. Let’s say Bob waits until March 15th of 2018 to take his first distribution, his next RMD will still be due on 12/31/2018, but will be based on the value of the accounts at the end of 2017.
Rollovers: The IRS requires that any RMD be taken from a qualified plan before a rollover to an IRA. Let’s say Bob retires on May 1, 2018 and after understanding all his options decides he wants to rollover his 401(k) into his existing Rollover IRA. If Bob were to do a complete trustee to trustee transfer on May 15, 2018, he might run in to a bit of an issue. Since the RMD rules state that qualified plans cannot be aggregated with any other qualified accounts, if Bob didn’t take the RMD first before the transfer, he will be stuck without the account from which he is required to take the RMD. If this takes place, the IRS actually sees this as Bob taking the RMD amount and trying to contribute it to the IRA, which is not allowed. So this will be treated as an excess contribution to an IRA that can be corrected without penalty by October 15th of the year after this “contribution” is made.
Finally, it’s important to keep an eye on Form 5498 in respect to RMDs. If there are errors in this reporting document, it can cause some real issues. Box 5 is important as this is the “Fair Market Value” of the retirement account at the end of the previous year. This is the amount that the IRS will look at first to determine if the full RMD was taken. If this amount is incorrect for any reason, a request can be made to get a corrected 5498 issued.
Content in this material is for general information only and not intended to provide specific financial or tax advice. Consult the appropriate advisor prior to making any financial or tax decisions.