Minimum distribution rules govern IRA accounts
Areader asked if I will provide a review of the required minimum distribution rules for IRA accounts. This is a common question that we receive in our firm, so it seems to be an always timely topic.
Because so many people have either contributed to Roth IRAs or have converted traditional IRAs into Roth accounts, I’ll also address the rules for Roth accounts.
The owner of an IRA must begin RMDs for the year in which he or she turns age 70½. A choice available in the first year permits the initial RMD to be deferred until April 1 of the year after the owner reaches 70½.
If the first distribution is deferred, then the owner must take two distributions in the year following the year in which the owner reaches 70½. Often, bunching the distributions causes the tax rate to be higher, including the tax effects of any other items that may be based on reported adjusted gross income.
Distributions may be taken over the owner’s life expectancy or a joint life expectancy with a designated beneficiary. The life expectancy for this purpose is redetermined each year in a more favorable manner than the “single life” expectancy discussed below for inherited IRAs.
The calculation of the RMD is based on the balance of the IRA on 12/31 of the year before the year of the RMD (e.g., 12/31/2016 is used for calculating a 2017 RMD). The calculation of the RMD is done separately for each IRA, but the aggregate RMD for the year may be satisfied from one account.
There are no RMDs for the owner of a Roth IRA. This is one of the key advantages of a Roth account. However, someone who inherits a Roth IRA must take distributions.
If the IRA owner begins to take RMDs and then passes away, his or her beneficiary must continue to take distributions. The rules for these distributions depend on the identity of the beneficiary.
A spouse beneficiary has the most options. The spouse may treat the IRA as their own, so that they are then subject to the “normal” distribution rules, with the spouse as the new owner of the account. They may also treat it as an inherited IRA and continue RMDs over their life expectancy.
Life expectancy for an inherited IRA is a bit different than a regular life expectancy calculation, because it is reduced by one year for each additional year that the beneficiary lives. A “normal” life expectancy figure does not get reduced by one year for each additional year the person lives.
A non-spouse beneficiary does not have the option to treat the IRA as his or her own. Therefore, distributions must begin by 12/31 of the year after the owner’s death. These distributions may be based on the beneficiary’s life expectancy, using the single life rules.
Obviously, life expectancy distributions require that the beneficiary have a measurable life. If the beneficiary fails this test (e.g., an estate, certain trusts), the distributions are based on the owner’s (table) life expectancy at death.
The rules are a bit different if the owner passes away before taking RMDs. A spouse beneficiary has similar rules to those discussed above, but also has the ability to withdraw the entire IRA balance by 12/31 of the fifth year following the owner’s death.
Also, the spouse beneficiary who treats the account as an inherited IRA can defer taking distributions until the year that the owner would have reached age 70½.
A non-spouse beneficiary who inherits the IRA before the owner took RMDs
must begin distributions by 12/31 of the year following the owner’s death and based on the beneficiary’s single life expectancy, or may use the five-year rule discussed above.
When the beneficiary lacks a life expectancy (again, an estate or certain trusts), the entire IRA must be distributed under the five-year rule if the owner dies before taking RMDs.
These rules are obviously hard to digest and hard to explain within the space limits of a column. It is important to have a qualified beneficiary designated before death and to ensure any trust named as beneficiary qualifies for life expectancy distributions (a lookthrough trust).