7 FAQs on Required Minimum Distributions

It is that time of the year again when our team is fielding questions from clients and prospects who are confused about Required Minimum Distributions (or RMDs). As with anything that needs an abbreviation and relates to government regulations, misunderstanding abound.

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To help you think through this complex topic, we have created an “RMD primer” article. In it, we address frequently asked questions and share our thoughts on the more technical aspects of the subject. We hope that this piece will become a helpful reference guide for you, your family, and friends who may need a blueprint to navigate this difficult and potentially expensive area of personal financial planning.

Question: “What is RMD and why should I care?”

What exactly is a Required Minimum Distribution?

The government mandates that individuals 70 ½ years of age must withdraw a certain minimum amount from their retirement savings accounts (including traditional IRAs, 401k accounts, and other retirement accounts) every year. The amount of the distribution is calculated based on the account balance and the life expectancy of the account holder (and, in certain cases, the life expectancy of his or her spouse).

Why is this done?

A key benefit of a pre-tax retirement savings account is that it reduces your taxable income and allows assets to grow tax-free until the funds are withdrawn. RMDs were put in place to nudge retirees to move some of that tax-deferred money into a taxable account – thus triggering some of the taxes during their lifetime. To encourage compliance, there are stiff penalties for failing to take out Required Minimum Distributions: namely, a fine in the amount of 50% of the “missed” RMD in addition to the taxes.


An important note: Roth IRAs do not have RMD requirements during the lifetime of the original account holder. That is because Roth IRA contributions are subject to tax, whereas qualified withdrawals are tax-free – the opposite of a Traditional IRA.


So, what does this look like in practice? Let’s look at an example to illustrate.

John, who is not married, turned 70 on February 1, 2018. His half-birthday (i.e the date that he turned 70 ½) is August 1, 2018. He has the following retirement savings accounts (all balances presented as of December 31, 2017 – which is the end of the year prior to John turning 70 ½).

  • Traditional IRA#1 $200,000

  • Traditional IRA#2 $100,000

  • Roth IRA $50,000

  • 401k from Company ABC $300,000

  • 401k from Company XYZ $400,000

By referencing the RMD calculation worksheet published by the IRS, we find that each account balance must be divided by 27.4 years (remaining life expectancy) to arrive at the estimated required annual withdrawal. Here is a chart that shows the math. Remember that Roth IRAs don’t trigger RMDs.

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So, John must withdraw the total of $36,496 for his RMDs. The rules allow him two opportunities for flexibility.

  • The RMDs related to John’s 401k accounts must come out of those accounts. However, he is allowed to combine the RMDs related to his IRA accounts and take them out of any of the IRA accounts that can satisfy the requirement. So, John can choose to draw down the IRAs proportionately ($7,299 from Traditional IRA#1, and $3,650 from Traditional IRA#2), or he could take the entire $10,949 out of IRA#1 or IRA#2. 

  • John can choose the timing of his initial Required Minimum Distribution. He can either take it during 2018 (which is the year he turned 70 ½), or he can wait and withdraw it before April 1 of 2019 (which is the calendar year after he turned 70 ½). This rule only applies to the initial RMD; all subsequent distributions must be taken within the same calendar year. There is no one strategy that’s “right” for everyone, so those who are facing their initial RMDs should consult with a financial planner to determine whether this one-time deferral makes sense for them.

Question: “What happens if I miss the deadline?”

What happens if John miscalculates the RMDs or forgets to take the withdrawal?

In that situation, there is a penalty. If John forgot about Traditional IRA#2 and only took $32,847 (which is the total of the RMDs from his Traditional IRA#1 and the two 401k accounts), his penalty would equal to 50% of the shortfall (i.e. $3,650 x 0.50) or $1,824. If he forgot to take any RMDs at all, his penalty would be half of $36,496 or $18,248.

Can something be done for damage control? In some cases, yes.

John can submit a request to waive the hefty penalty, which the IRS may grant if it finds “reasonable cause” for the oversight. There is no published record of what constitutes reasonable cause, but those who missed the deadline due to financial institution error or serious illness should make a request for a waiver (and remedy the situation as soon as the error is discovered).

Question: “What dates are important for RMDs?”

As we saw in the case of John above, missing the deadline for RMDs can result in significant penalties. Even if penalties are waived, you must make up for the shortfall immediately and still take the next round of RMDs on schedule – a combination that could push you into a higher tax bracket for that year. So, you must be clear on when your initial RMD is due in order to avoid unnecessary expenses.

Here are the rules.

The initial RMD must be taken during the calendar year when the individual turns 70 ½ (or before April 1 of the following year). Depending on your birth date, this math can cross calendar years and look confusing. Here are two examples to illustrate.

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There is an important exception to the RMD timing rule that must be mentioned here. Those who are actively employed at age 70 ½ can delay taking their RMDs from the 401k (or similar) account associated with their current employer. So, if John from our example above is still employed at Company XYZ, his initial RMD is reduced from $36,496 to $21,898. This exception only applies to the 401k account with Company XYZ, and only if John is less than a 5 percent owner of the company.

Question: “I have heard something about donating my RMDs. How does that work?”

Many retirees rely on distributions to meet their financial needs in retirement. However, there are some situations where an individual already receives sufficient cash flow to maintain his or her standard of living – before taking any RMDs. Minimum withdrawals may be unavoidable, but what happens if you don’t need that money for your living expenses and would rather not trigger additional taxable income?

In this situation, your financial planner may recommend setting up a qualified charitable distribution (QCD). Yes, while you are required to take certain minimums out of your retirement accounts, you don’t necessarily have to keep that money. A qualified charitable distribution instructs the custodian to cut a check that’s payable directly to a charitable organization. By doing this, you meet the RMD requirements and don’t create any taxable income.

Here are a few more specifics.

  • Only IRA (traditional or inherited) accounts are eligible. If you have a SEP or SIMPLE IRA, the plan must be inactive in order to qualify for QCDs.

  • The funds must come out of your IRA and go directly to the custodian. If you break the chain and take the funds into your own account, you must pay taxes on it – even if you ultimately donated the money to a qualified charity.

  • The maximum annual amount that falls under QCD protection is $100,000.

  • You can instruct the custodian to mail the check directly to the charity, or you can mail it yourself.

  • Not every charity is eligible to receive QCDs. Research the organization and ask your financial planner before you instruct the custodian to cut the check.

Question: “What about inherited accounts?”

If the original owner of an IRA dies and leaves the account to a non-spousal beneficiary (such as a child), the recipient has an option to set up an Inherited IRA.

The specifics of Required Minimum Distributions will depend on the situation. For example, if the original owner has started to take RMDs before passing, the child would then be required to continue withdrawing RMDs – but at a rate that’s based on his or her own life expectancy (which would typically result in a smaller required minimum distribution).

Inherited Roth IRAs have their own rules for non-spousal beneficiaries, as do traditional IRAs inherited by a spouse. Talk to your financial planner to understand the requirements and to choose the best strategy.

Question: “What about market performance and distribution timing?”

Stock market performance has sustained a long upward run over the past few years, but markets can be expected to fluctuate. What happens if you find yourself having to take out an RMD at a time when the market has taken a beating, and when selling your investments would force you to realize significant losses?

In this situation, you may talk to your financial planner about in-kind distributions.

The rules don’t require you to take cash out of the retirement account, only that you take a minimum distribution and pay taxes on it (unless it is a qualified charitable distribution, in which case there are no taxes). So, it may be possible to transfer your investment holdings “in-kind” (i.e. as stock or fund shares) to a personal account in a way that satisfies the rules and doesn’t force you to sell them. Of course, this strategy presumes that you don’t need the cash to cover your expenses, and that you are willing to hold on to your investments with an eye towards value recovery.

Question: “I have read about legislative proposals to change the rules around RMDs. Should I worry about this?”

Not in the immediate future.

Here are our thoughts on recent legislative proposals.

  • A recent Presidential directive instructed the Treasury to update life expectancy tables that are used to calculated RMDs. The last update took place 16 years ago, and this step would align the tables with the most current actuarial data that reflects advances in medical care. The expected change isn’t dramatic (a typical 70-year-old retiree would get an extra 2 years added to life expectancy), and the resulting reduction in RMDs (and the tax deferral) will be small for most people. If you are curious about the technical aspects of this proposed update, take a look at this article from Michael Kitces.

  • There is a proposal to create a Universal Savings Account (USA) with a relatively low annual contribution limit ($2,500) and tax-free withdrawals regardless of purpose, and to eliminate RMDs on employee-sponsored retirement accounts with balances under $50,000. If implemented, both would have a minimal effect on most of our clients.

  • Finally, there is a proposal to eliminate the “stretch IRA” rule which currently allows a spouse who inherits an IRA account to roll it over into his or her own IRA with no immediate tax consequences (or wait to begin taking RMDs until the deceased spouse would have turned 70 ½).  If the stretch option is eliminated, the inheriting spouse would have to empty out the account within 5 years, paying taxes on the withdrawals as they go. If is difficult to predict the progress and speed of any legislature, especially one as complex as this, so the possibility of stretch IRAs disappearing is worth keeping on your radar.

Your questions about RMDs

As technical as this article is, it can only scratch the surface on the subject of Required Minimum Distributions. We have covered a few common questions, from an overview of RMDs to a few specific applications such as charitable contributions and inherited accounts.

If you have a question that we haven’t answered, feel free to email us at [email protected]  – perhaps we can do a Round 2 on this topic. Or, better yet, call our team at Phillip James Financial to get expert personalized advice about your financial situation.