Retirement Accounts: Distribution Rules

| December 8, 2014 | 0 Comments

With the year-end approaching, an important deadline for retirement account owners is also coming, so this column will deal with some of the rules surrounding IRAs and distributions. A significant caveat applies here: the rules can be very complex and people have literally written books on the topic. So I won’t be able to cover the full complexity in 650 words! Also, this column won’t address Roth IRAs which are very different.

Individual Retirement Accounts (IRAs) and Qualified Retirement Plans (QRP) like pensions, 401k and 403b plans, have similar distribution requirements. Because you generally receive a tax deduction for the money you put into these accounts, the distributions are usually taxable when you pull money out.

Generally, you must begin taking distributions in the year that you turn 70.5, and your first distribution must be taken out of the account by April 15th of the following year. Every subsequent distribution must be taken by December 31st. So, if you turned 70.5 in 2014 and you wanted to wait until April 2015 to take your first Required Minimum Distribution (RMD), you would also have to take your second distribution by December 31 of next year, creating two taxable distributions in the same year. We generally advise against this but it really depends on your circumstances.

The most important point is: don’t forget to take your RMD! If you forget, the IRS can hit you with a penalty of 50 percent of the amount you should have taken plus the taxes due on the distribution. OUCH!

The RMD amount changes each year and is based on the account value as of 12/31 of the prior year. So, to calculate your 2014 RMD, start with the account value on your 12/31/2013 statement. That value is divided by a factor which can be found in the life expectancy tables published by the IRS in Publication 590. The calculation essentially forces you to withdraw a slightly larger portion of your account value each year. For most people, the first RMD will be about 3.7 percent of your account value. By the time you reach age 100, your RMD will be about 16 percent of your account value. Note that for married couples with a spouse more than 10 years younger, the calculation is similar but different tables must be used.

The instructions in Publication 590 explain these rules in greater detail. Brokerage firms are also required to notify you as to what they think the RMD should be. Finally, if you have multiple IRAs, you can aggregate your RMDs and withdraw the entire amount from a single account.

IRAs that you inherit from someone other than a spouse also have RMDs, but they are calculated very differently. You should either review the IRS rules or work with your financial team to ensure you get this one correct.

The mechanics of actually taking the distribution are fairly straight-forward. You can do it in one lump sum or spread it out over periodic payments; whatever will work best for your circumstances. You can also withhold taxes from the RMD payments in order to avoid having to make estimated tax payments. Your financial advisor, brokerage or mutual fund company can generally help you with this process.

QRPs are a little different in that if you are an employee, you may not be required to take an RMD until you retire. However, if you are retired during any portion of a calendar year and you are 70.5 or older, you must take a full year’s RMD for that year! Someone who is more than a five percent owner of a company usually IS required to take the RMD even if he or she is still working in the business.

That’s enough IRS regs for one month. In my next column, I’ll address IRA beneficiaries and Trusts.

This column is prepared by Rick Brooks, CFA, CFP®. Brooks is Vice President for Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Brooks can be reached at (858) 755-5166, or by email at brooks@bfadvisers.com. He and his family live in Mission Hills.

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