Although required minimum distributions (RMDs) are now mandatory components of tax-deferred retirement plans, this was not always the case. RMD rules began to apply to qualified plans following the Tax Reform Act of 1986, after policy makers noticed that retirement account holders were saving the funds for their beneficiaries rather than their own retirement spending. A plan retains qualification by following rules designed to delay taxation until the participant’s retirement. However, required minimum distributions require participants to start withdrawing funds from retirement plans and IRAs at a certain age so that the deferred taxes can be recouped.

Fast-forward to the current day, where the RMD rules have continued to evolve as a result of the SECURE Act of 2019 and SECURE 2.0 Act of 2022. To help keep you informed, this article will discuss the most important aspects of RMDs in their present form.

Who needs to take an RMD?

An RMD must be taken in the year the participant reaches age 73. Your plan document may have an exception for participants who continue to work after age 73. This exception, however, does not apply to individuals with more than 5% ownership, including attributed ownership, of the company that sponsors the plan.

When must an RMD be taken?

RMDs are due by the end of the calendar year to avoid paying an excise tax. The participant’s first RMD can be delayed until April 1st of the following year; this is called the required beginning date. The taxation of the first RMD should be considered when deciding whether to take the money by the end of the year or delay it until the following year. If the first RMD is delayed, two taxable distributions will be made in the same year.

How much is distributed as an RMD?

For a defined contribution plan, the RMD amount is calculated by taking the account balance (as of the end of the preceding calendar year) and dividing it by a value which estimates life expectancy. The IRS provides tables to determine this value based on the beneficiary’s age and the age of their spouse, if applicable. Prior to 2024, both pre-tax and designated Roth accounts were part of this calculation; beginning in 2024, however, designated Roth accounts are not subject to the RMD rules while the account owner is still alive.

An RMD can’t be rolled over, so it is not subject to the mandatory 20% Federal Income Tax withholding. Instead, the default tax withholding rate for an RMD is 10%. The participant can choose to withhold more or less than this 10%, or even elect to waive the withholding. However, even if the withholding is waived, the amount distributed will still be considered taxable income for the participant.

What happens if an RMD isn’t taken?

The excise tax for failing to take an RMD used to be 50%. SECURE 2.0 lowered this to 25%; however, the excise tax may be further reduced to 10% if a correction is made within two years. This excise tax is paid by the participant, but there may be additional consequences for the plan as a whole. If the RMD isn’t taken on time, the plan could be considered disqualified. Disqualification means that the plan is no longer tax exempt, and funds held by the trust are immediately taxable.

If the participant has an account balance in more than one plan, RMDs must be taken from each plan. Also, taking an RMD from an IRA does not satisfy the requirement to take the RMD from a plan. The RMD for each plan is calculated independently.

Although RMDs are a taxable distribution to the participant, as the plan sponsor, you can help ensure they are issued timely by verifying that dates of birth are correct on the year-end census. In addition, if your plan document has an exception for individuals over 73 who are still employed, dates of termination are critical for those participants. If a question arises regarding when a certain employee is required to receive a distribution, a closer look at age, employment status, and ownership information can help determine the correct answer.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

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