What Are Required Minimum Distributions (RMDs)?

What Are Required Minimum Distributions (RMDs)? By Gayle McKearin, Special to bizNEVADA

Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty. The RMD rules are
calculated to spread out the distribution of your entire interest in an IRA or plan account over your
lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement
accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required
minimum distributions generally have the effect of producing taxable income during your lifetime.

WHICH RETIREMENT SAVINGS VEHICLES ARE SUBJECT TO THE RMD RULES?

In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to
the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive. Although you are
not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will
generally be required to take distributions from the Roth IRA after your death. Employer-sponsored
retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus
plans, and qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b)
plans are also generally subject to these rules. If you are uncertain whether the RMD rules apply to your
employer-sponsored plan, you should consult your plan administrator or a tax professional.

WHEN MUST RMDS BE TAKEN?

Your first required distribution from an IRA or retirement plan is for the year you reach age 70½.
However, you have some flexibility as to when you actually have to take this first-year distribution. You
can take it during the year you reach age 70½, or you can delay it until April 1 of the following year.

Since this first distribution generally must be taken no later than April 1 following the year you reach age
70½, this April 1 date is known as your required beginning date. Required distributions for subsequent
years must be taken no later than December 31 of each calendar year until you die or your balance is
reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following
year, you will be required to take two distributions during that year — your first year’s required
distribution and your second year’s required distribution.

Example: You have a traditional IRA. Your 70th birthday is December 2, 2017, so you will reach age 70½
in 2018. You can take your first RMD during 2018, or you can delay it until April 1, 2019. If you choose to
delay your first distribution until 2019, you will have to take two required distributions during 2019 —
one for 2018 and one for 2019. This is because your required distribution for 2019 cannot be delayed
until the following year.

There is one situation in which your required beginning date can be later than described above. If you
continue working past age 70½ and are still participating in your employer’s retirement plan, your
required beginning date under the plan of your current employer can be as late as April 1 following the
calendar year in which you retire (if the retirement plan allows this and you own 5% or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar
year.

Examples: You own more than 5% of your employer’s company, and you are still working at the
company. Your 70th birthday is on December 2, 2017, meaning that you will reach age 70½ in 2018. So
you must take your first RMD from your current employer’s plan by April 1, 2019 — even if you’re still
working for the company at that time.

You participate in two plans — one with your current employer and one with your former employer. You
own less than 5% of each company. Your 70th birthday is on December 2, 2017 (so you’ll reach 70½ on
June 2, 2018), but you’ll keep working until you turn 73 on December 2, 2020. You can delay your first
RMD from your current employer’s plan until April 1, 2021 — the April 1 following the calendar year in
which you retire. However, as to your former employer’s plan, you must take your first distribution (for
2018) no later than April 1, 2019 — the April 1 after reaching age 70½.

HOW ARE RMDs CALCULATED?

RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life
expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31
of the year preceding the calendar year for which the distribution is required to be made.

Example(s): You have a traditional IRA. Your 70th birthday is November 1 of year one, and you,
therefore, reach age 70½ in year two. Because you turn 70½ in year two, you must take an RMD for year
two from your IRA. This distribution (your first RMD) must be taken no later than April 1 of year three. In
calculating this RMD, you must use the total value of your IRA as of December 31 of year one.

Caution: When calculating the RMD amount for your second distribution year, you base the calculation
on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age
70½) regardless of whether or not you waited until April 1 of the following year to take your first
required distribution.

For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your
account balance as of December 31 of the prior year by your distribution period, determined under the
Uniform Lifetime Table using your attained age in that calendar year. This life expectancy table is based
on the assumption that you have designated a beneficiary who is exactly ten years younger than you
are. Every IRA owner’s and plan participant’s calculation is based on the same assumption.

There is one exception to the procedure described above — the younger spouse rule. If your sole
designated beneficiary is your spouse, and he or she is more than ten years younger than you, the
calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your
spouse. (The life expectancy factors can also be found in IRS publication 590.) Consequently, if your
spouse is your designated beneficiary and is more than ten years younger than you, you can take your
RMDs over a longer payout period than under the Uniform Lifetime Table. If your beneficiary is not your
spouse or a spouse who is not more than ten years younger than you, then you must use the shorter
payout period specified in the Uniform Lifetime Table.

Tip: In order for the younger spouse rule to apply, your spouse must be your sole beneficiary for the
entire distribution year. Your spouse will be considered your sole beneficiary for the entire year if he or
she is your sole beneficiary on January 1 of the year, and you don’t change your beneficiary during the
year. In other words, even if your spouse dies, or you get divorced after January 1, you can use the
younger spouse rule for that distribution year (but not for distribution years that follow). In the case of
divorce, however, if you designate a new beneficiary prior to the end of the distribution year, you
cannot use the younger spouse rule (since your former spouse will not be considered your sole
beneficiary for the entire year).

If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the
required amount from any one or more IRAs. Inherited IRAs are not included with your own for this
purpose. (Similar rules apply to Section 403(b) accounts.) If you participate in more than one employer
retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.

SHOULD YOU DELAY YOUR FIRST RMD?

Remember, you have the option of delaying your first distribution until April 1 following the calendar
year in which you reach age 70½ (or April 1 following the calendar year in which you retire, in some
cases).

You might delay taking your first distribution if you expect to be in a lower income tax bracket in the
following year, perhaps because you are no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution
must be made on or by December 31 of that same year.

Receiving your first and second RMDs in the same year may not be in your best interest. Since this
“double” distribution will increase your taxable income for the year, it will probably cause you to pay
more in federal and state income taxes. It could even push you into a higher federal income tax bracket
for the year. In addition, the increased income may cause you to lose the benefit of certain tax
exemptions and deductions that might otherwise be available to you. So the decision of whether to
delay your first required distribution can be important and should be based on your personal tax
situation.

Example(s): You are single and reached age 70½ in 2017. You had a taxable income of $25,000 in 2017
and expect to have $25,000 in taxable income in 2018. You have money in a traditional IRA and
determined that your RMD from the IRA for 2017 was $50,000 and that your RMD for 2018 is $50,000 as
well. You took your first RMD in 2017. The $50,000 was included in your income for 2017, which
increased your taxable income to $75,000. At a marginal tax rate of 25%, federal income tax was
approximately $14,489 for 2017 (assuming no other variables). In 2018, you take your second RMD. The
$50,000 will be included in your income for 2018, increasing your taxable income to $75,000 and
resulting in federal income tax of approximately $12,439. Total federal income tax for 2017 and 2018
will be $26,928.

Now suppose you did not take your first RMD in 2017 but waited until 2018. In 2017, your taxable
income was $25,000. At a marginal tax rate of 15%, your federal income tax was $3,284 for 2017. In
2018, you take both your first RMD ($50,000) and your second RMD ($50,000). These two $50,000
distributions will increase your taxable income in 2018 to $125,000, taxable at a marginal rate of 24%,
resulting in federal income tax of approximately $24,289. Total federal income tax for 2017 and 2018
will be $27,573 — $645 more than if you had taken your first RMD in 2017. 1

WHAT IF YOU FAIL TO TAKE RMDs AS REQUIRED?

You can always withdraw more than you are required to from your IRAs and retirement plans. However,
if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal
penalty. The penalty is a 50% excise tax on the amount by which the RMD exceeds the distributions
actually made to you during the taxable year.

Example: You own one traditional IRA and compute your RMD for year one to be $7,000. You take only
$2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at
least $7,000 as a distribution but have only taken $2,000, your RMD exceeds the amount of your actual
distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50%
of $5,000).

Technical Note: You report and pay the 50% tax on your federal income tax return for the calendar year
in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, “Additional
Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The tax can be waived if you
can demonstrate that your failure to take adequate distributions was due to “reasonable error” and that
steps have been taken to correct the insufficient distribution. You must file Form 5329 with your
individual income tax return, and attach a letter of explanation. The IRS will review the information you
provide and decide whether to grant your request for a waiver.

CAN YOU SATISFY THE RMD RULES WITH THE PURCHASE OF AN ANNUITY CONTRACT?

Your purchase of an annuity contract with the funds in your IRA or retirement plan satisfies the RMD
rules if all of the following are true:
• Payments are made at least yearly
• The annuity is purchased on or before the date that distributions are required to begin
• The annuity is calculated and paid over aa time period that does not exceed those
permitted under the RMD rules
• Payments, with certain exceptions, do not
increase

If you participate in a 401(k) or similar plan, or an IRA, you may also be able to use up to 25% of your
account balances (up to a maximum of $125,000 from all accounts, indexed for inflation) to purchase a
qualifying longevity annuity (or QLAC). The value of the QLAC is disregarded when you calculate the
amount of RMDs you are otherwise required to take from your account each year. Payments from the
QLAC can be delayed up to age 85, and are treated as satisfying the RMD rules when paid. The rules can
be complicated, and QLACs are not right for everyone, so be sure to consult a qualified professional for
further information. (Note: Any annuity guarantees are subject to the claims-paying ability and financial
strength of the annuity issuer.)

TAX CONSIDERATIONS

Income tax

Like other distributions from traditional IRAs and retirement plans, RMDs are generally subject to
federal (and possibly state) income tax for the year in which you receive the distribution. However, a
portion of the funds distributed to you may not be subject to tax if you have ever made after-tax
contributions to your IRA or plan.

For example, if some of your traditional IRA contributions were not tax deductible, those contribution
amounts will be income tax-free when you withdraw them from the IRA. This is simply because those
dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any
after-tax contributions.

Your distribution may also be income-tax-free if it is a qualified distribution from a Roth 401(k), 403(b),
or 457(b) account. Generally, an RMD is qualified if your Roth account satisfies a five-year holding period
requirement. If your RMD is not qualified, then generally only the portion of the RMD paid from your
Roth account that represents earnings will be taxable to you – your own contributions to the Roth
account are returned tax-free.

Because RMDs are paid after you turn age 70½, or after your death, they are not subject to early
distribution penalties. Income taxes on RMDs paid to your beneficiary after your death are generally
calculated in the same manner as if the payments were made to you.

Caution: Taxable income from an IRA or retirement plan is taxed at ordinary income tax rates even if the
funds represent a long-term capital gain or qualifying dividends from stock held within the plan. Note
that there are special rules for capital gain treatment in some cases on distributions from employer-
sponsored retirement plans.

Estate tax

You first need to determine whether or not the federal estate tax will apply to you. If you do not expect
the value of your taxable estate to exceed the federal applicable exclusion amount, then the federal
estate tax may not be a concern for you. However, state death (or inheritance) tax may be a concern. In
some cases, your assets may be subject to more than one type of death tax – for example; the
generation-skipping transfer tax may also apply. Consider getting professional advice to establish
appropriate strategies to help reduce and possibly eliminate your future estate tax liability.

For example, you might reduce the value of your taxable estate by gifting all or part of your required
distribution to your spouse or others. Making gifts to your spouse can sometimes work well if your
taxable estate is larger than your spouse’s, and one or both of you will leave an estate larger than the
applicable exclusion amount. This strategy can provide your spouse with additional assets to better
utilize his or her applicable exclusion amount, thereby minimizing the combined estate tax liability of
you and your spouse. Be sure to consult an estate planning attorney, however, about this and other
possible strategies.

Caution: In addition to the federal estate tax, your state may impose its own estate or death tax. Consult
an estate planning attorney for details.

INHERITED IRAs AND RETIREMENT PLANS

Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or
beneficiaries) will then typically be required to take minimum distributions from the account. A spouse
beneficiary may generally roll over an inherited IRA or plan account into an IRA in the spouse’s name,
allowing the spouse to delay taking additionally required distributions until he or she turns 70½.

As with required lifetime distributions, proper planning for required post-death distributions is essential.
You should consult an estate planning attorney and/or a tax professional.

The information contained in this report does not purport to be a complete description of the securities,
markets, or developments referred to in this material. Investments mentioned may not be suitable for all
investors. The material is general in nature. Past performance may not be indicative of future results.
Raymond James Financial Services, Inc. does not provide advice on tax, legal or mortgage issues. These
matters should be discussed with the appropriate professional. Securities offered through Raymond
James Financial Services, Inc., member FINRA/SIPC, an independent broker/dealer, and are not insured
by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial
institution, are not guaranteed by the financial institution, and are subject to risks, including the possible
loss of principal.

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