Avoiding Mistakes in Required Minimum Distributions

Generally, retirement account owners who are at least age 70½ must withdraw required minimum distributions (RMD) from their retirement accounts by Dec. 31. In the first RMD year, individuals may be able to defer the RMD to the next year until the required beginning date. But you may not want to do that.

"Say, for example, Sam turns 70 on June 1, 2017," says Carol Berger, CFP®, Berger Wealth Management, Peachtree City, GA. "Sam would be 70½ on December 1, 2017. His initial (2017) RMD would be due by April 1, 2018. However, his subsequent RMDs are due by Dec. 31, so Sam’s RMD for 2018 would be due by December 31, 2018. If Sam’s IRA is rather large, that means potentially two sizeable taxable withdrawals in the same year!"

"This could bump Sam into a higher tax bracket (and maybe subject him to the Medicare surcharge, depending on his adjusted gross income, or AGI)," adds Berger. "Recommending to Sam that he take his initial RMD by the end of 2017 could potentially save him in taxes by spreading the withdrawals over 2017 and 2018."

Those who withdraw less than the RMD amount by the deadline will owe the IRS an excise tax of 50% of the shortfall. That means you must take care to ensure you withdraw a sufficient amount to meet your RMD. This means avoiding some pitfalls when calculating the RMD for a retirement account.

The RMD for a year is determined by dividing the previous year-end's fair market value (FMV) by the applicable distribution period. (For more insight, read up on calculating your retirement plan RMDs.) Your IRA custodian usually provides a report of your FMV by Jan. 31 of the following year.

"The IRS has a uniform table of divisors that is used to calculate annual RMD amounts,"  says Jillian C. Nel, CFP®, CDFA, Director of Financial Planning at Legacy Asset Management, Inc., Houston, Texas. "Your age at the end of the calendar year will determine the factor used. The amount considered when dividing this factor is the year-end value of your IRA or qualified dollars for the previous year."

"For example, the 2017 RMD will use the Dec. 31, 2016, value of the account divided by the factor given by the IRS for your age on Dec. 31, 2017," Nel explains. "If there is limited information on the year-end value (i.e., lost statements, movement of accounts, hard-to-value assets within the portfolio), this calculation can be challenging."

However, if in the current year you re-characterized a conversion for the previous year or rolled over a distribution from the previous year, your custodian may not be aware of these transactions and may not have included those amounts in your FMV. You must, therefore, figure out your RMD with these current-year re-characterizations and conversions. Let's look at the following examples:

Example 1 Michael reached age 74 in 2017. In March 2017, he contacted his IRA custodian for assistance with calculating his RMD. The custodian used Michael's previous year-end FMV of $100,000 and his distribution period of 23.8. According to the custodian's calculation, Michael's RMD for 2017 is $4,202. However, in September 2017, he decided to re-characterize $200,000 he converted to his traditional IRA in 2016. Michael is required to adjust his previous year-end FMV by the re-characterized amount. This would make his RMD approximately $12,605 – an $8,403 difference. If Michael fails to withdraw the additional $8,403 from his traditional IRA by December 31, 2017, he will owe the IRS an excise tax (excess accumulation penalty) of $4,201.

Example 2 Jane reached age 73 in 2017. She contacted her IRA custodian in Jan 2017 for assistance with calculating her RMD amount. The custodian used Jane's previous year-end FMV of $50,000 and her distribution period of 24.7 to calculate the RMD amount of $2,024. In February 2017, Jane decided to roll over the $150,000 that she withdrew from the IRA in December 2016. Jane's RMD must be re-figured by including this $150,000 in the FMV, resulting in an RMD difference of $6,073 ($8,907-$2,024). If Jane fails to withdraw the additional amount by December 31, 2017, she will owe the IRS an excise tax of $3,037.

If you have multiple retirement accounts, you are allowed to combine and withdraw the multiple RMDs from one retirement account; however, only RMDs from certain types of retirement plans can be combined. The following combinations are permitted:

• If you have multiple traditional IRAs, you may calculate each IRA's RMD, combine these RMDs, and withdraw the total amount from one traditional IRA.
• If you have multiple 403(b) accounts, you may calculate each 403(b)'s RMD, combine all these RMD amounts, and withdraw the total amount from one 403(b).
• If you have multiple inherited/beneficiary IRAs from the same decedent, you may choose to combine life-expectancy distributions for those inherited IRAs and withdraw the total from one inherited IRA.

You may not combine the RMD amount for different types of retirement plans. The following are examples of combinations that are not allowed:

• You may not combine the RMDs for multiple qualified plans. "If you have 401(k) plans from former employers, you would need to take RMDs on those, and, unlike IRAs, you would need to calculate the RMD for each plan and take that amount from each account," says Fred Leamnson, ChFC, Founder and President of Leamnson Capital Advisory, Reston, VA. "Unlike IRAs, RMDs from 401(k) plans cannot be taken from one account."
• You may not combine RMD amounts for different types of plans. For instance, an RMD amount for a 403(b) account may not be withdrawn from a traditional IRA or vice versa, and the RMD for a 403(b) account may not be withdrawn from a qualified plan.
• RMD amounts for inherited/beneficiary IRAs may not be withdrawn from traditional IRAs that you own.

Example 3 Sam inherited an IRA from his Aunt Suzie. The RMD amount for the inherited IRA is $6,000. Sam has his own IRA that he funded himself with regular and rollover contributions, and this year the RMD amount for his own IRA is $10,000. Sam cannot combine the two RMD amounts and withdraw from only one. Each RMD must be withdrawn from its respective account.

If you have multiple inherited/beneficiary IRAs from different decedents, you may not combine distributions for those inherited IRAs.

Then there's the Roth confusion. "Roth IRAs for individual participants are not subject to RMDs, but inherited Roth IRAs are," notes Marguerita M. Cheng, CFP®, RICP®, CEO of Blue Ocean Global Wealth, Gaithersburg, MD.

Should you inadvertently combine RMD amounts for different types of retirement plans, an RMD shortfall will result for the retirement plan from which you withdrew no RMD. Say, for instance, that the RMD for your qualified plan is $10,000 and the RMD for your traditional IRA is $5,000. If you withdraw $15,000 from the traditional IRA and make no withdrawal from the qualified plan account, you will not have satisfied the RMD for your qualified plan account and will owe the IRS an excise tax amount of $5,000 (50% of the shortfall).

If you fail to withdraw your RMD amount from the proper account(s), you could end up owing the IRS large excise taxes. Taking a few additional steps can help you to avoid these penalties. Before calculating your RMD, check to see if you made rollover contributions after the end of the year. Additionally, if you decide to re-characterize conversions after the end of the year, be sure to re-figure your RMD amount. Most important, be sure to inform your custodian of these adjustments.