What does the Internal Revenue Service mean by “Required Minimum Distribution”? The Required Minimum Distribution (RMD) is a portion of a pre-tax account that must be distributed to the account holder after he/she has reached age 72 (in year 2020 and after) and is no longer employed by the Plan’s sponsor. Even if the account holder is still employed, he/she must take the required minimum distribution from any previous employers’ plans and any individual retirement accounts (IRAs) he/she might possess.
For example, Biff turns 72 on April 1st this year—no fooling. He is currently employed by his own business and has a 401(K) plan. Years ago, Biff worked for a couple of school systems, a city government motor pool, and two car rental companies amassing assets in two 403(b)s, a 457, and two 401Ks. He consolidated these into one big IRA when he opened his own business.
Biff will not have to take an RMD from his 401K, because he is still employed by the Plan sponsor, but he will have to take an RMD from the IRA. The IRS requires the first RMD to be paid to the account holder no later than April 1st following the year he/she turns 72. That means that Biff could wait until sometime in the first quarter of next year to take his first RMD. However, that will mean he has two distributions next year. He will have one based on the year he turned 72 due by April 1, plus one for the year he turned 73 due by December 31.
How is the RMD Calculated? The RMD formula is calculated using the December 31st prior year account value and a factor referenced in the age tables in IRS Publication 590. Most financial institutions that sponsor pre-tax plans will calculate the RMD for an individual account automatically. However, they will not distribute it unless the account holder asks for it.
Can I take it from just one account for all my accounts? One must take RMDs by plan type. The account holder may choose to take the RMD from just one account of each plan type. For example, if Biff still had two 403(b) accounts, a 457 account and two 401(k)s, he could take the RMD from each account—meaning he would receive a total of five checks for annual distributions. Or he could have calculations made in each plan type and take enough from one account in each plan type to satisfy the RMD for that plan type. For example, if Biff had two 403(b)s of equal value with a combined RMD of $5,000. Biff could take all $5,000 from one of the accounts and leave the other alone. Or he could take $1,000 from one and $4,000 from the other as long as the total amount adds up the $5,000. Biff cannot take a heaping sum from his former employers’ 401Ks to cover his 403(b)s and 457 as well as his 401Ks. He must take at least three distributions—one per plan type.
This is why Biff consolidated all the plans into a well-diversified IRA. He still gets the diversification he needs but does not have to request three different RMD calculations. He needs just one distribution annually from the consolidated IRA.
After the first year, can I choose what time of year I want my RMD? Yes, those subject to RMDs can take them any way they wish. They can take a lump sum, monthly installments, quarterly, or semi-annual payments as long as they reach the required minimum distribution by December 31 of each year. Payments can be made via electronic funds transfer, paper checks, or delivery of in-kind shares to an after-tax account as long as the taxes due are made in cash to the IRS. Ask your advisor what options are available to you.
Many financial service firms allow account holders to sign up for automatic RMDs payable on a specified date each year. For example, a portion of Biff’s investment pays an annual dividend each June. Biff sets up his automatic RMD payment for each July 1, thus maximizing his dividend.
What happens if I don’t request my RMD? Let’s review: the term is REQUIRED MINIMUM DISTRIBUTION. This is the minimum distribution required to be received and taxed after all these years. If you fail to take your RMD, the IRS will find out—eventually. You will still have to take the missed RMD and pay the normal taxes due on it, plus, there is a penalty equal to 50% of the amount you should have taken but failed to take. Let’s say your RMD was $10,000 and you forgot to take it. Let’s assume your ordinary taxes would be 20% Federal and 5% state. That’s $2,500 federal, plus $500 State, plus $5,000 in penalty. (That’s $8,000 to taxes and $2K to you if you don’t take it.) So, check in with your advisor around birthday 72. You will be glad you did.
