Nov 29, 2017
Required minimum distributions (RMDs) are mandatory, annual withdrawals that participants must take when they turn 70 1/2 years old and are no longer employed or when they work past that age then retire. These Internal Revenue Service (IRS) rules apply to holders of 401(k), 403(b) and profit-sharing plans, as well as individual retirement accounts (IRAs), SEPs [simplified employee pension plans] and SIMPLE [savings incentive match plan for employees] IRAs. For IRAs, SIMPLE IRAs and SEPs, participants must take the RMD at 70 1/2, regardless of employment status.
Those qualifying to take their first RMD must do so no later than April 1 the year after they pass this threshold. Thereafter, participants must take them annually, no later than December 31.
Participants may withdraw more than their RMD each year or space out partial payments. Like the required withdrawal amount, the money will be taxed as regular income based on an individual’s federal income tax rate and any applicable state and local taxes. However, participants have until the applicable deadline to take the full RMD for the year.
“Any withdrawals participants take throughout the course of the year will count toward their RMD for that year,” says Tim Driscoll, director, defined contribution product management, at Fidelity Investments in Boston. “If someone doesn’t want to take his entire RMD in a lump sum, he can spread his withdrawals out for any given frequency that we can calculate.”
For 401(k) plans, RMDs can be calculated by dividing the balance of an account as of December 31 the year prior to the one in which the RMD is taken, by an applicable life expectancy factor on the Uniform Lifetime Table from the Internal Revenue Service (IRS).
Driscoll says participants with multiple 401(k)s must take an RMD from each account. That is, they may not calculate the RMD for each account, combine them and then withdrawal that sum from a single 401(k). The IRS limits this method to only certain types of plans, notably 403(b)s.
Where such pooling is allowed, only accounts from the same type of plan may be considered together—not, for example, a 403(b) account plus a traditional IRA.
If a participant’s spouse is 10 or more years younger than the participant and is the sole beneficiary, the participant may use the IRS’ Joint Life and Last Survivor Expectancy table to determine the RMD.
While these calculations can be tricky for many, some recordkeepers offer participants tools and services to help them determine their RMDs, while also guiding them through the withdrawal process.
Can Recordkeepers Help?
First, it is important to make sure plan sponsors and recordkeepers keep track of the correct contact information for participants, especially those approaching or past age 70 1/2.
Driscoll says his firm periodically sends these participants notices via traditional mail to remind them about RMDs—how to take them and any other relevant information.
“We send a first-year notification letter at the beginning of the year, notifying them that they will have to take RMDs soon, as well as a worksheet dictating their election options and Q&A documentation explaining RMDs,” Driscoll says. “Every year, we also send an RMD advice letter to employees who are still employed past 70 1/2, informing them that they may have to start taking RMDs if they separate from employment.”
Driscoll notes, “For participants who don’t take action and initiate a withdrawal, we have an RMD auto-generation feature. And, at the end of the year, we’ll create the distribution and send them a notice with the required amount. We’ll process the distribution on their behalf and generate all the relevant tax reporting and notices.”
Are There Exceptions?
Unless participants own 5% or more of the business sponsoring their retirement plan, they may, as noted earlier, delay taking RMDs from their 401(k) or 403(b) plan past age 70 1/2, until they retire. Accountholders of Roth 401(k)s and/or Roth IRAs are not required to take RMDs on those funds, as taxes have already been paid. However, the pertinent RMD rules will apply for a sole beneficiary.
How Do RMDs Apply to Beneficiaries?
According to the IRS, beneficiaries of employer retirement accounts—IRAs, as well—calculate RMDs using the Single Life Table. This can be accessed when using Form 590-B, by referring to Table I, Appendix B: Distributions From Individual Retirement Arrangements. The table shows a life expectancy based on the beneficiary’s age. The account balance is divided by this life expectancy to determine the first RMD. The life expectancy is reduced by one year for each subsequent year.
Beneficiaries must take an RMD for the year of the accountholder’s death, using the RMD that person would have received. The following year, the RMD will be calculated according to the particulars of the beneficiary.
Thus, it is important for plan sponsors and recordkeepers to clearly communicate the specific implications of RMDs to beneficiaries, who may be less engaged with the retirement account than the original holder was.
Consequences of Not Taking an RMD
Participants who fail to take RMDs when required can face a 50% excise tax based on the amount that should have been withdrawn. Plan sponsors should maintain frequent contact with participants close to needing to take their first RMD.
However, this penalty can be challenged. “The IRS recognizes that some individuals may have good reason that they didn’t take out an RMD,” says attorney Deborah L. Grace, with Dickinson Wright in Detroit. “So individuals can file Form 5329 and request a waiver of the penalty.”
Forgiveness of the penalty would be determined on a case by case basis. “It’s always better for the participant to discover it and reach out to the IRS than the IRS figuring it out in an audit,” Driscoll says. “My understanding is they will be a little more lenient in that case.”
What About Annuities?
Annuities may be treated differently under RMD rules. For example, says Driscoll, under those rules, a 401(k) plan may permit participants to use up to 25% of their account balance, or $125,000, whichever is less, to purchase a qualified longevity annuity contract [QLAC], but it will not be included in the RMD calculation.”
As a general rule, qualified contracts such as those held in individual retirement accounts (IRAs) are subject to the same RMD rules as other qualified retirement investments. However, nonqualified contracts are based on after-tax deferrals. So, they typically do not require withdrawals until annuitization, as is defined by the annuity’s contract.
Things That May Get Overlooked
As all participants responsible to take RMDs from their 401(k) must do so from each account they hold, plan sponsors need to keep track of former employees who still have assets in the plan.
Sponsors should also point out the need to cash RMD checks, which may be mailed to retired participants. Letting these sit uncashed can technically put a participant in violation of RMD requirements.“Plan sponsors share the responsibility with their participants from a fiduciary or administrative perspective in making sure participants are satisfying their requirements,” Driscoll concludes.
- The IRS RMD rules govern mandatory, annual withdrawals that participants of 401(k), 403(b) and profit-sharing plans generally must make when they turn 70 1/2 years old and are no longer employed or when they work past that age then retire.
- For each 401(k) account, an RMD can be calculated by dividing the account balance, as of December 31 the year before the one in which the RMD is taken, by an applicable life expectancy factor on the IRS’ Uniform Lifetime Table.
- It is important that plan sponsors and recordkeepers keep track of the correct contact information for terminated, active participants, especially those near 70 1/2 or older.