Understanding required minimum distributions (RMDs)



Please note: Due to the CARES Act required minimum distributions (RMDs) will be suspended for 2020.

If an investor has taken RMDs in the past but has forgotten some of the rules, or if an investor has just turned 72 (70 1/2 if born before 7/1/49), here are some important things to consider about these mandatory withdrawals.

What is an RMD and how is it calculated?

If an investor has a Traditional, Rollover, SEP, SAR-SEP, or SIMPLE IRA, the IRS requires that they withdraw a minimum amount from the account each year, beginning in the first calendar year after they turn 72 (70 1/2 if born before 7/1/49). An investor has to withdraw this money by April 1 of that year even if the investor is still working. An investor is then required to take another withdrawal from their IRA by December 31 of that same year and every year thereafter. This withdrawal is known as a Required Minimum Distribution. On the other hand, if an investor has a 401(k), Profit Sharing, or Money Purchase Plan, and owns less than 5% of the company they work for, they do not have to take a withdrawal until the first calendar year after they turn age 72 or retire, whichever is later.

If an investor owns a Roth IRA, they are not subject to an RMD. An investor can leave money in their account without taking withdrawals for as long as they live since Roth IRAs do not require withdrawals until after the death of the account owner.

The amount of an RMD is based primarily on two factors—the account balance at the end of the previous year and a life expectancy factor. The IRS uses the investor’s age to determine the life expectancy factor from a uniform lifetime table. However, if the investor’s spouse is more than 10 years younger, and is the sole primary beneficiary of the account, the investor can use a joint life expectancy table, which may result in a lower RMD amount. Both of these tables can be obtained in IRS Publication 590-B.  

What about multiple IRAs? An investor must calculate their RMD for each IRA separately. Then, the investor can withdraw an RMD from each account, or they can add up the RMD amount from each IRA (no need to include RMDs from 401(k) plans), and withdraw the aggregate amount from only one IRA. Alternatively, an investor may want to consider consolidating IRAs that are subject to an RMD into one account. By consolidating IRAs, they’ll only need to calculate and withdraw an RMD from one account each year. 

Forgetting to take an RMD may result in a 50% IRS penalty on the amount not distributed as required. For example, if an RMD was $50,000 but only $20,000 was disbursed that year, an investor would be subject to a $15,000 penalty (50% of the undistributed $30,000). Here at E*TRADE, we can help with the funds distribution each year. An investor can complete an IRA distribution form online (log-in required) and request automatic withdrawals to satisfy the RMD on a monthly, quarterly, or annual basis.

RMDs due to death

When an investor is the beneficiary of a retirement plan or an IRA, there are specific rules that regulate the minimum withdrawals that must be taken. Generally, the first year that beneficiaries must take a withdrawal from an IRA is December 31st following the year the original account holder passed away. For example, if an IRA owner passed away on February 1, 2020, the beneficiary would need to take his or her first withdrawal by December 31, 2021. However, if the original owner was over age 72 at the time of death and had not yet withdrawn an RMD for 2020, the beneficiary would also be required to withdraw that amount before the end of 2020.

Final thoughts

When it comes to RMDs, different people have different opinions. Some look forward to making their withdrawals, while others absolutely dread it. Remember that an investor can always withdraw more than the minimum if need be. If an investor is lucky enough not to need funds from the IRA, there are a number of options they can take to minimize the impact of withdrawal requirements. If an investor is still working, remember that they may not be required to take an RMD from a 401(k) plan, though the investor will still need to make a withdrawal from any Traditional or other pre-tax IRAs. For details on RMDs from a 401(k), please consult with the plan administrator.

If an investor is concerned about selling securities to meet an RMD, they shouldn’t be. When taking a distribution, an investor is not required to take it in cash. Shares can be distributed from an IRA into a non-retirement brokerage account. Even though an investor is only moving the shares, the distribution is taxable, so make sure that the market value of the shares equals the RMD that needs to be withdrawn. In addition, if an investor has had significant losses in their IRA, they may want to consider converting it to a Roth IRA. This may enable an investor to avoid future RMDs on those accounts. Although they will be required to pay taxes on the converted amount (at a lower basis), any growth in a Roth IRA will be tax-free after five years.

For any questions, please visit the comprehensive RMD Resource Center (log-in required), which includes FAQs and options for an RMD. Or, give us a call at 800-387-2331 (800-ETRADE-1).

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