Contributions to various retirement plans, including Individual Retirement Arrangements (IRAs) and 401(k) plans, remain one of the most legitimate tax shelters in the Internal Revenue Code. Contributions result in immediate deductions, and investment earnings grow tax deferred. Over the years, Congress has attempted to expand the tax benefits in this area through increases in deduction limits and new retirement plan vehicles. Ultimately, taxpayers must begin to withdraw funds from most retirement plans in accordance with the Required Minimum Distribution (RMD) rules.
The general rule is that an individual must begin receiving distributions from their retirement plan by April 1 of the year following the year in which they attain age 70½, referred to as the required beginning date. For example, an individual with a birthdate of July 19, 1946 reached age 70 on July 19, 2016 and reached age 70½ on January 19, 2017. Thus, in this instance, the required beginning date is April 1, 2018. The retirement plan custodian more often than not will compute the amount of the RMD based on the account holder’s life expectancy. A taxpayer can always receive more than the RMD.
If a taxpayer fails to receive a RMD in a timely fashion, the taxpayer faces a 50% excise tax on the amount not distributed. If the excess accumulation is due to reasonable error, and the taxpayer has taken or is taking steps to remedy the insufficient distribution, the taxpayer can request that the 50% excise tax be waived. Using the above facts, the initial RMD is for 2017. While it must be received by April 1, 2018, the taxpayer can take it during 2017, the year in which age 70½ was attained. The RMD for any year after the year in which age 70½ is attained must be made by December 31 of that later year. If a taxpayer delays receipt of their initial RMD until the following year, they will end up with two distributions in that year. Using the same example, if the initial RMD is not received until sometime in 2018 (by April 1), the second RMD will need to be received by December 31, 2018. Depending on the taxpayer’s circumstances, it may be beneficial to take the initial RMD in the preceding year (2017), so as not to end up with two distributions in one year, which could push the taxpayer into a higher tax bracket.
Another reason to avoid receiving two RMDs in the same year is to take advantage of state pension exclusions. New Jersey provides a pension exclusion of $20,000 for single taxpayers and $40,000 for joint filers who are over age 62 as long as total gross income does not exceed $100,000. New York provides an annual pension exclusion of $20,000 for each spouse who has attained age 59½. As an aside, age 59½ has significance, as any distributions received from taxable retirement accounts prior to attaining this age that are not rolled over within 60 days are subject to a federal 10% premature distribution penalty in addition to being subject to tax. There are a number of exceptions to the premature distribution penalty, the most common one being an inherited distribution from a decedent.
For distributions from an employer retirement plan, the required beginning date is the later of
April 1 following the year in which age 70½ is attained, or the calendar year in which the employee retires from employment, with the employer maintaining the plan as long as the employee is not a 5% or greater owner of the employer. Visit the IRS website for useful publications pertaining to retirement plans, including Pub. 560, Retirement Plans for Small Business, and Pub. 590-B, Distributions from Individual Retirement Arrangements.