Think…do you know anyone who turned age 70 last year? If yes, and they turned seventy during the first half of 2016, then they must take a Required Minimum Distribution (RMD) from their IRA(s) no later than April 1, 2017. Failure to do so will result in a 50% federal penalty unless they can get an exception from the IRS (Form 5329). If they turned age seventy during the second half of 2016, they could wait until April 1, 2018 to take their first RMD. However, they’ll be required to take two RMDs in 2018, both taxable as ordinary income.
Regarding IRA RMDs, the penalties are harsh and the rules can be confusing so let’s lay out some of the more common scenarios:
- Your IRA. The IRS requires you begin taking a RMD no later than April 1st of the year following the year you turn age 70½. Yep, leave it to the government to make something that could be simple, more complicated. So, if your seventieth birthday plus six months landed in 2016, your deadline for your first RMD was April 1, 2017. In this case, the amount of your RMD is based on the value of your IRA on December 31st, 2015 and comes from an IRS table that is based roughly on your life expectancy and amounts to around 3.5% of your IRA balance. Each year the percent of the distribution rises since your life expectancy is shorter. And don’t forget if you waited to take your first RMD in 2017 (due before April 1) you also have to take your 2017 RMD before December 31, 2017 as well.
- Your Spouse is your beneficiary. As beneficiary, your surviving spouse has two options:
- Do an IRA Rollover. If your spouse chooses to roll over your IRA into his/her name, he/she will simply follow the RMD rules when he/she turns age 70½.
- Leave your IRA in your name. This is referred to (and titled) as an ‘inherited IRA’. If you died after beginning RMDs, your surviving spouse can use his/her own life expectancy for calculating RMDs (if he/she is younger than you) or use your life expectancy (if he/she is older than you). If you died before beginning your RMDs, your surviving spouse can wait until you would have begun RMDs and begin RMDs based on his/her life expectancy or he/she could rollover your IRA into his/her name and postpone RMDs until their own required beginning date for RMDs.
- A non-spouse is your beneficiary. When a non-spousal beneficiary, such as a son, is the beneficiary of your IRA, he does not have the option to rollover your IRA into his name. Instead, it must be set up as an ‘inherited IRA’. If you die before beginning your RMDs, he can either begin taking RMDs using his own life expectancy or he can withdraw all funds within five years. The first option allows for greater tax deferrals. If you die after beginning your RMDs a non-spouse beneficiary, say a sibling, can take RMDs based on either your life expectancy or his/her life expectancy…typically choosing the longer life expectancy for greater tax deferrals.
- For Roth accounts. Roth IRAs have special rules, the most important being that the original owner of a Roth IRA is never subject to RMDs. This is also true for a spouse beneficiary who rolls the Roth account over into his/her own name. Secondly, distributions are never taxable no matter who is the owner. However, a non-spouse beneficiary must:
- Take RMDs based on his/her life expectancy or
- Withdraw all funds within five years.
The Takeaway: It’s complicated…so seek professional help to make certain you avoid a potential 50% penalty!