After One-Year Hiatus Required Minimum Distributions Return
Holders of traditional individual retirement accounts (IRAs) and 401(k) plans over the age of 71 take note – required minimum distributions, or RMDs, are back.
The RMD rules require most account holders age 72 and older to withdraw a minimum amount each year based on the age of the account owner and the value of the owner's accounts at the end of the previous year. The withdrawal is generally taxable.
When the markets tanked in 2020 in response to the COVID-19 outbreak, many retirees subject to the RMD rules were put in a difficult position. First of all, the amount of the RMD would be based on an account value that might no longer be there. Value declines of 30% or more were not uncommon. Also, to fund the RMD, the owner might be forced to sell retirement investments at the worst possible time, when their value had declined substantially. Not exactly a good investment strategy.
Fortunately, the CARES Act, the COVID-19 economic stimulus bill passed into law in early 2020, provided relief for this situation by suspending the RMD mandatory requirement for tax year 2020. Many of my clients took advantage of this suspension, allowing their accounts to participate more fully in the market recovery, while also lowering their 2020 income tax bill.
It was thought early on that Congress might choose to extend this suspension for 2021 since the pandemic has continued. However, with the markets rebounding as robustly as they have, no such extension has been forthcoming, thus retirees who are required to do so must take an RMD for 2021, generally by the end of the year.
With that said, let's take a look at the RMD rules, so you will know what, if anything, you need to do.
First, let's answer the question, who must take an RMD? RMDs for traditional IRAs and 401(k) plans must begin with the year you reach age 72 (prior to 2020, the age was 70½). For the first RMD, i.e., in the year you reach the qualifying age, you can take the distribution at any point during that year all the way up to April 1 of the following year. So, if you turn 72 in 2021, you have until April 1, 2022 to satisfy the initial RMD requirement.
Each subsequent year's RMD must be taken by December 31 of that year. It's important to note that if you do defer the initial year RMD until April 1 of the following year, you still must take the second year's RMD by that year's last day. In other words, you will end up with two RMDs in a single year, which could push you into a higher tax bracket, so plan carefully.
You do not have to take the entire RMD in a single lump sum. It is allowable to take it in a series of distributions if you prefer, so long as your total at the end equals or exceeds the RMD amount. Also, if you have your IRA funds spread among multiple accounts, you do not have to pull money from each account. For purposes of the RMD, all of your traditional IRAs are treated as one, so the RMD can be satisfied from any or all of the accounts, even pulling only from a single one.
So, how is the RMD amount determined? The RMD is calculated based on the value of the retirement accounts at the end of the prior year, your age and the IRS life expectancy tables. Most investment firms and tax professionals can help with the calculations, and calculators aplenty are available online.
Also, if you have both a 401(k) account and IRAs, the RMD for the 401(k) and the IRAs must be calculated and distributed separately from each other.
Are there any exceptions to taking an RMD? Indeed there are. An important exception is that Roth IRAs are not subject to the RMD rules. While a Roth 401(k) is subject to the rules, you can easily get around this if you want by rolling over the Roth 401(k) account into a personal Roth IRA.
Another exception is for employees age 72 or older who still work for the employer that sponsors the 401(k) and who doesn't own more than 5% of the company.
Finally, as with most things in the tax law, there is a consequence if you fail to take your RMD during the year in the form of a tax penalty. This penalty is an onerous 50% of the RMD amount. If you fail to take an RMD and have reasonable cause, it may be possible to get the penalty waived, but it's not guaranteed, so you want to avoid that by any means.
Lane Keeter, CPA, is Office Managing Partner of the Heber Springs office of EGP, PLLC, CPAs & Consultants (a full-service financial firm with offices in Heber Springs, North Little Rock and Bryant) and past winner of The Sun-Times Reader's Choice Award for Best Accountant