Most people are familiar with the significant income tax benefits of contributing to a qualified retirement plan such as a 401(k) plan, or an individual retirement accounts (IRA). One advantage of these types of arrangements is the taxpayer has significant flexibility and control on the timing of the receipt of income from the qualified retirement plan or IRA. However, this flexibility is not unlimited and Congress has enacted very specific rules that require annual distributions from these plans.
Unless certain limited exceptions apply, annual distributions must begin by April 1 following the year a taxpayer attains age 70 1/2. These annual distributions are typically referred to as required minimum distributions or RMDs. Failure to withdraw the RMD in any year can result in a significant penalty. If a taxpayer fails to withdraw the required amount from the qualified plan or IRA, the taxpayer may have to pay a 50% excise tax on the amount not distributed as required. This blog addresses a key aspect of complying with the RMD rules, which is identifying the required beginning date.
The first step to determine if you need to make a withdrawal from an IRA or other qualified plan account to satisfy the RMD rules is to determine your required beginning date. As described below, the required beginning date for a traditional IRA will be April 1st following the year the taxpayer attains age 70 1/2, but if the taxpayer is still employed and is a participant in a retirement plan, then other factors affect the analysis.
For a taxpayer who has a 401(k) account (or other qualified plan account), the required beginning date is April 1st of the calendar year following the later of: (a) the year the taxpayer turns age 70 1/2 or (b) the year the participant retires from employment with the employer maintaining the plan, unless the plan participant is a 5% owner (i.e. a plan participant who owns 5% or more of the stock of the employer sponsoring the retirement plan), in which case the age 70 1/2 date still applies.
There are several subtle implications to the preceding rules. First, the determination of the required beginning date is made on an account by account basis. A taxpayer may have a 401(k) account where the April 1st following the year he turns 70 1/2 is not the required beginning date (because the taxpayer has not retired and is not a 5% owner), but if the same taxpayer has a separate IRA account, the participant must begin taking distributions from the IRA by April 1st following the year he turns 70 1/2. Second, all accounts that require a minimum distribution must be combined to determine the amount of the RMD and the RMD is required for each calendar year commencing with the year the taxpayer attains age 70 1/2. Although distributions may be made no later than the required beginning date to avoid the 50% excise tax penalty, the year to which the first distribution relates is the prior calendar year.
As noted above, after the required beginning date, RMDs must be withdrawn no later December 31st of each calendar year. Thus, after a taxpayer has crossed the required beginning date, all other distributions, including the year in which the required beginning date occurs, must be made by December 31st of the calendar year to which it relates. Whether distributions should be deferred to the required beginning date or withdrawn in year the taxpayer attained age 70 1/2 is a more complex question that will be addressed in a subsequent post.
There are limited exceptions to the RMD rules. The RMD rules do not apply to Roth IRAs while the owner is alive, but they do apply to employer-sponsored designated Roth and Roth 401(k) accounts during the participant’s lifetime. Second, although defined benefit plans, more commonly known as pension plans, are not exempt from the RMD rules, generally the form of distribution permitted by these plans will satisfy the RMD rules.
In summary, for an IRA owner the required beginning date is April 1st following the calendar year in which the owner turns 70 1/2. For a taxpayer whose retirement account is a 401(k) or qualified plan account the required beginning date is determined by the age of the participant, the employment status of the taxpayer, and the type of account held by the participant. Because of the significant income tax penalties and the complexities of the RMD rules, taxpayers should consult a competent tax advisor to make sure the required beginning date is correctly determined.