[Note: This Letter is an educational publication designed to provide a general background for understanding IRAs. It is not a substitute for professional tax advice. Readers considering the implementation of an IRA are encouraged to consult with a qualfied financial advisor or tax professional. This Letter references tax rates and IRA parameters for 2016. If you are reading this after 2016, then new rates and parameters may apply. You can check the True Vine Letter IRA archives for more recent updates or visit the Internal Revenue Services (IRS) website at irs.gov. IRS Publications 590-A (Contributions to Individual Retirement Arrangements) and 590-B (Distributions from Individual Retirement Arrangements) cover IRAs and they are usually updated on an annual basis. The IRS Tax Map for IRAs is also a helpful resource.]
All assets in retirement plans must eventually be distributed to their owners or their beneficiaries (if they are deceased). The Internal Revenue Service (IRS) has structured the IRA rules so the advantages of tax deferral do not last forever. In this Letter we will look at “Required Minimum Distributions” (RMDs)—the amount that must be distributed each year for certain IRA owners. If you live long enough you will have to take money out even if you do not need it. I will focus solely on RMDs as they pertain to original owners of Traditional IRAs (or Rollover IRAs which are essentially the same thing). Original owners of Roth IRAs are not required to take distributions during their lifetimes, only their eventual beneficiaries. I will cover required distributions for inherited IRAs in a separate Letter. It is critical to understand how this process works, because IRA owners who do not take the proper amount of annual distributions on time may have to pay a 50% excise tax on the amount not distributed.
Please note that special rules apply for Individual Retirement Annuities. If your Traditional IRA is an Individual Retirement Annuity and you are approaching age 70, then I highly recommend contacting the individual who sold you the annuity and ask them (1) when you need to take your first distribution, (2) to calculate the minimum amount for you, and (3) what you need to do to take the distribution. Ideally, they should be notifying you ahead of time. If not, find yourself a new adviser.
Who Needs To Take RMDs?
The requirement to withdraw a minimum amount annually from your Traditional IRA does not kick in until you are age 701/2 so if you are not even close to this age (say, 59 or less) you are done with this Letter unless you really enjoy learning about IRAs. If you are at least in your 60s, then I recommend that you keep reading. It will be helpful to begin to think about this minimum amount of annual income you will have when you reach 701/2 and how it will will fit into your overall retirement income plan (notably, the tax implications).
Required Beginning Date
The first thing you need to know is the beginning date (year) in which you are required to begin taking distributions. This is called your “Required Beginning Date,” which I will hereafter simply refer to as RBD. If you are the original owner of an IRA then your RBD is April 1 of the year after you turn 701/2. For all subsequent years, the deadline is December 31. You generally cannot defer the RBD for your IRA even if you continue to work. If you are still working for a company where you have a retirement plan (e.g., a 401(k)) you can defer your RBD for that company plan until April 1 of the year after you retire, unless you own more than 5% of that company.
You can withdrawal your RMD in each applicable year in whatever increments you desire as long as your total withdrawals for the year are equal to at least the minimum required amount. For example, if your RMD for 2017 is $1,200 you could take monthly withdrawals of $100 in 2017 to satisfy the requirement. If you take out extra for any given year you cannot apply it towards future years.
Be careful if you take your first and second RMDs in the same year. This could push you into a higher income tax bracket. For example:
Jack turned 701/2 in 2015. He had until April 1, 2016 to take his first RMD, which was calculated to be $30,000. Jack did not withdrawal the $30,000 from his IRA until February 2016. In August 2016 he withdrew another $30,000 for his 2016 RMD. Jack had to report $60,000 of taxable income for 2016, which pushed him into a higher marginal tax bracket (28% vs. 15%).
Calculating Your RMD
Here are the steps required to calculate your RMD:
Determine the account balance to use. This is the balance of your account on December 31 of the year before the distribution year. For example, if you turn 701/2 in 2016, then you would need to use your account balance as of December 31, 2015. [If you are taking your RMD from a company retirement plan (e.g., a 401(k)) consult your plan agreement. It is possible that the plan specifies a date other than December 31.]
Determine the “Applicable Distribution Period” (ADP) number to use.
If your spouse is the only primary beneficiary of your account and is more than ten years younger than you are, do the following:
For your first distribution year, take your age and your spouse’s age on your birthdays in the year you turn 701/2. Use the ADP number next to that age in the Joint Life and Last Survivor Expectancy Table (Table II in Appendix B of IRS Publication 590-B, available online at: https://www.irs.gov/pub/irs-pdf/p590b.pdf).
Your ADP is determined the same way in subsequent distribution years (as long as your spouse is still the sole beneficiary and more than ten years younger).
For everyone else, do the following:
For your first distribution year, take your age as of your birthday in the year you turn 701/2. Use the ADP number next to that age in the Uniform Lifetime Table (Table III in Appendix B of IRS Publication 590-B, available online at: https://www.irs.gov/pub/irs-pdf/p590b.pdf).
Your ADP is determined the same way in subsequent distribution years.
3. Divide the account balance by the ADP to calculate your RMD.
Required Minimum Distribution = Account Balance / Distribution Period
If you have more than one Traditional IRA you must calculate the RMD for each one separately, but you can take total amount from only one of or several of your Traditional IRAs if you wish.
Note that the law requires IRA custodians to tell IRA owners older than 701/2 either the amount of the RMD or the fact that it is required. If the custodian only gives you notice that it is required, they must offer to calculate the amount for you. They also must identify those IRAs for which a minimum distribution is required. I recommend calculating it yourself (or asking your investment adviser to do it for you) and getting the number from your custodian(s) to double check your amount. Make sure they match!
Joshua Hall, ChFC
The True Vine Letter is a publication of True Vine Investments, the investment advisory business of Joshua S. Hall, ChFC, a Registered Investment Adviser in the U.S.A. The information presented in The True Vine Letter is provided for educational purposes only and not to be used or considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities, investment products or other financial instruments. The True Vine Letter is prepared for general circulation. It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may read this letter. You should independently evaluate specific investments and consult a professional before making any investment decisions.
All data presented by the author is regarded as factual, however, its accuracy is not guaranteed. Investors are encouraged to conduct their own comprehensive analysis.