Pay close attention to required minimum distribution rules

The oldest baby boomers (those born in the year 1946) began turning age 70.5 in summer of 2016 and have begun taking required minimum distributions (“RMDs”) under IRS guidelines for at least one if not two tax years now (2016 and 2017). The rules surrounding RMDs can be confusing and mistakes can be costly. Below are a few tips to keep in mind when managing your RMDs.

• Make Sure You Get Your First RMD Out On Time — Most mistakes happen around the time when it’s required you take your first distribution out. The fact that the IRS picks age 70.5 (instead of age 70 or 71) only adds to the confusion. Long story short, the latest you can take your first RMD is April 1 of the year following the calendar year you turn age 70.5. Each subsequent RMD from then on must be taken out by Dec. 31 of each year. Also, keep in mind that if you choose to defer your first RMD until April 1 of the year after you turn 70.5, you must take two distributions in the same tax year (one distribution to account for the previous year’s RMD must come out by April, and then a subsequent RMD to account for the current year RMD must come out by Dec. 31). Let’s look at an example: John Smith has a birthday of March 1, 1947. John reached age 70.5 in 2017. He could have chosen to take his first RMD by Dec. 31, 2017 or by April 1, 2018 at the latest. If he chose to defer his first RMD until April 1, he will need to take out a second RMD to account for the current year by Dec. 31, 2018. Each subsequent year after 2018, John will need to take out his RMD by Dec. 31.

• Understand Which Accounts Require RMDs — Pretty much any account in which you’ve contributed money pre-tax and it’s been allowed to grow tax deferred throughout the years is likely going to require you to begin taking required distributions once you reach age 70.5. In general, IRAs (including SEPs and SIMPLEs) require RMDs beginning at age 70.5. Roth IRAs typically do not require RMDs. Qualified retirement plans (401(k)s, 403(b)s, etc.) also typically require you to begin RMDs at age 70.5. Now, there are exceptions to the rules surrounding RMDs from qualified retirement plans so work with a qualified advisor who can explain when you may be eligible to defer RMDs beyond age 70.5 for these types of accounts.

• Avoid Common Mistakes — There are several common mistakes that we see when it comes to taking required distributions. One example might be that a husband and wife are both over age 70.5 and both have their own respective traditional IRAs. Instead of properly calculating and taking required distributions from each account, they lump the RMDs together and take it from one account. The mistake made is that IRAs are individually owned. You can’t lump your RMD with that of a spouse and take it from one account. So let’s say the husband and wife lumped their RMDs and took it all from the wife’s traditional IRA. In essence, she will have taken out more than she was required to for the year and the husband will not have taken out enough and will likely owe a 50 percent tax penalty on the amount that was supposed to be withdrawn from his account.

Another common mistake is not taking your RMD for the year prior to initiating a direct rollover from a qualified retirement plan to an IRA if you are age 70.5 or over. You must take your RMD first prior to initiating the direct rollover otherwise the amount subject to the RMD may be treated as an excess contribution in the IRA account. Let’s look at John Smith again. Assume John has an old 401(k) and an IRA. John would like to consolidate his old 401(k) into his IRA. Prior to initiating a direct rollover, he must request his RMD for the 401(k) account be distributed. 

As you can see, it’s easy to make a mistake regarding required distributions from various retirement accounts. There are many rules beyond what is mentioned in this article so it’s important to work with a qualified advisor regarding your individual situation.

Gary E. Croxall, CFP®

Registered Principal of LPL

Soren E. Croxall, CFP®

LPL Registered Sales Assistant

Securities and Advisory Services offered through LPL Financial, member FINRA/SIPC, a Registered Investment Advisor. LPL Financial and Croxall Capital Planning do not provide tax or legal advice. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  Securities and advisory services offered through LPL Financial, a Registered Investment Advisor,  Member FINRA/SIPC.