Avoiding Common Errors Surrounding RMDs

November 06, 2018

Presented by Lauren E. Robbins, CFP®

When it comes to retirement accounts, many investors fail to think about required minimum distributions (RMDs). This oversight can lead to unnecessary tax burdens and other financial issues. In order to handle RMDs effectively, an understanding of the rules and common misconceptions can be beneficial.

Misconception:I took an RMD from my 401(k).This will satisfy both the RMD for that account and the one I have to take for my IRA and any other account.

What the rules say: RMDs can be aggregated for certain accounts. For instance, if you have two traditional IRAs and each has an RMD of $1,000, you can withdraw $2,000 from one account to satisfy both RMDs. RMDs for SEP and SIMPLE IRAs can be aggregated with traditional IRAs as well.

This same RMD aggregation rule can be applied to multiple 403(b) plans. You cannot, however, take an RMD from a 403(b) plan to satisfy an RMD from an IRA. And when it comes to 401(k)s and other non-IRA accounts, such as profit-sharing plans, you must take a separate RMD from each plan.

Misconception: My mother passed away and left me her IRA. She hadn’t yet taken an RMD for the year. I don’t need to take one either.

What the rules say: When you inherit a traditional IRA from which the decedent (i.e., original account owner) was taking RMDs, it is up to you as the beneficiary to satisfy any missed distribution and to pay the taxes on that distribution at your marginal tax rate. If there are multiple beneficiaries, the RMD amount is typically divided among the group, and each person is responsible for paying taxes on his or her portion from his or her own IRA beneficiary distribution account (BDA).

Tip: When multiple siblings are involved, one beneficiary may want to take a lump-sum distribution of the inherited account, rather than continue taking RMDs from an IRA BDA. In this case, the sibling taking the lump sum could use some of those funds to satisfy the decedent’s missed RMD, leaving the other siblings’ IRA BDAs intact until they reach their required beginning date and have to start taking their personal RMDs. Of course, this would require the sibling taking the lump-sum distribution to agree to the solution.

Misconception:I inherited an IRA BDA from a relative. I can base the RMDs on my own life expectancy.

What the rules say: Generally, RMDs from an inherited retirement vehicle are based on the beneficiary’s life expectancy. That isn’t the case when the account was previously inherited by another person—in that situation, the RMDs continue to be based on the previous beneficiary’s life expectancy. So, if A dies and leaves an IRA to B, B now has an IRA BDA. When B dies and leaves the IRA BDA to C, C must withdraw RMDs as if B, the original beneficiary, were still alive.

Misconception:I inherited a Roth IRA. I know my own Roth does not have RMDs. The same rule must apply to this inherited account.

What the rules say: Even though the account is a Roth IRA, because it is an inherited IRA—and, thus, a BDA—it is subject to IRA BDA rules, which means that RMDs must be taken.

Misconception:I just retired and have a substantial RMD due from my 401(k) plan and a small RMD due from my traditional IRA. I can just roll the 401(k) into the IRA and take the smaller RMD.

Quick Facts About RMDs

  • RMDs generally begin at age 70½.
  • IRA RMDs can be aggregated.
  • 403(b) plan RMDs can be aggregated.
  • Qualified plan RMDs (i.e., 401(k) or profit-sharing plans) cannot be aggregated.
  • IRA-based plans (SEPs, SIMPLEs, and SARSEPs) always have RMDs at age 70½.When inherited, both Roth and traditional IRAs have RMDs.
  • Designation Roth accounts (i.e., Roth 401(k)s, 403(b)s, and 457(b)s) have RMDs.

What the rules say: Although you can roll your 401(k) into a traditional IRA, the RMD amount is not eligible for rollover and must be taken from the 401(k) prior to the rollover. If, for some reason, the financial institution allows the RMD to be rolled with the other eligible assets, action must be taken to remove the RMD amount from the receiving IRA. Technically, the RMD amount attributed to the 401(k) was satisfied when the rollover occurred and now represents an ineligible excess contribution in the IRA. The RMD amount for the 401(k) must be removed as a return of excess contribution from the IRA (not a normal distribution) and returned to you.

Tip: The rules state that the required beginning date (RBD) for RMDs from a noninherited IRA is April 1 of the year following the year in which the account owner turns age 70½ or retires, whichever is later. The account owner in the above example, who retired in 2018, would have until April 1, 2019, to take RMDs from both accounts. The amounts of the RMDs would be based on the year-end 2017 value of each account.

Misconception:I am still working, so I don’t have to take an RMD from my SEP or SIMPLE IRA at my current employer.

What the rules say: Although you do not have to take an RMD from a 401(k) plan if you are still working, this exception does not exist for SEP or SIMPLE IRAs. Once you reach age 70½, regardless of employment status, RMDs need to come out of SEP and SIMPLE plans.

Ironically, if you are still working and active in the SEP or SIMPLE plan, you can continue to make contributions, even though you are also taking RMDs.

Misconception:I have a Roth 401(k) or 403(b), and just like my Roth IRA, I don’t need to take RMDs.

What the rules say: One of the more puzzling rules regarding RMDs is the fact that Roth 401(k) and Roth 403(b) plans both have RMDs. This is after-tax money, so the RMD does not increase your tax burden like a distribution from a traditional IRA would, but it can be a nuisance because, if you miss taking it, you will incur a 50-percent penalty. It may be smart to roll over these designated Roth accounts into a Roth IRA prior to the date you must start taking RMDs. Be aware, however, that if an RMD is due, that portion of the account balance is ineligible for rollover.

© 2018 Commonwealth Financial Network®