I receive a lot of questions during the year from my clients and others about required minimum distributions. In this article I want to explain what they are and how they work.
The idea behind a required minimum distribution is to take a dollar that has never been taxed in the past and subject it to taxation. Dollars that have never been taxed in the past are those that have been contributed to 401(k) and IRA accounts. In addition, the growth of these accounts have never been taxed either.
The IRS is very eager to collect the taxes that are due on this money and have created a mechanism to force the distribution of funds out of qualified retirement accounts. This is called a Required Minimum Distribution or RMD.
Under most conditions once the account owner of a qualified retirement account reaches the age of 70 1/2 the IRS requires that they distribute as taxable income a minimum amount.
The calculation of a required minimum distribution involves the following fraction:
Total qualified retirement account balance as of December 31 of the previous year
Account Owner’s life expectancy from the Uniform Life Table of the IRS
It is incumbent on the account owner to calculate the RMD do each year and ensure that proper distributions have been taken and claimed on tax returns. Many financial institutions, however, assist account owners in automatically calculating these amounts and reporting it to the account owner.
It is very important that the correct amount of distribution occurs before the end of the calendar year. For amounts not taken that should have been distributed from qualified retirement accounts the IRS imposes a 50% excise tax on the amount not taken.
The IRS allows distributions to be taken in multiple ways. For example, for all IRA account balances calculated, the RMD can be taken in a pro-rata amount from each IRA or from a single IRA. Note that the IRS treats IRA accounts and company retirement plan accounts as separate entities requiring separate calculations.
If you have any questions about RMDs please contact me.