Avoiding Common Errors Surrounding RMDs from Qualified Plans

RMD picture.jpgWhen it comes to their retirement accounts, many investors often fail to think about required minimum distributions (RMDs). An RMD is the minimum amount that participants in qualified plans—like 401(k)s and 403(b)s—must withdraw from their accounts annually once they reach age 70½. Failing to take an RMD can lead to unnecessary tax burdens and other financial issues, so it’s important to understand the rules—and the common errors people make.

Common error: I took an RMD from my 401(k). This will satisfy both the RMD for that account and the one I have to take for my IRA—or any other account for that matter.

What the rules say: RMDs can be aggregated for certain accounts. For instance, if you have multiple traditional IRAs, you can take an RMD from one account that equals the total amount of RMDs you would have to take from all accounts. So, if you have two traditional IRAs and each has an RMD of $1,000, you can withdraw $2,000 from one account to satisfy both RMDs. RMDs for SEP- and SIMPLE IRAs can be aggregated with traditional IRAs as well.

This same RMD aggregation rule can be applied to multiple 403(b) plans, too. You cannot, however, take an RMD from a 403(b) plan to satisfy an RMD from an IRA. And when it comes to 401(k)s and other non-IRA accounts, such as profit-sharing plans, you must take a separate RMD from each plan.

Common error: I just retired and have a substantial RMD due from my 401(k) plan and a small RMD due from my traditional IRA. I can just roll the 401(k) into the IRA and take the smaller RMD.

What the rules say: Although you can roll your 401(k) into a traditional IRA, the RMD amount is not eligible for rollover. If, for some reason, the financial institution makes a mistake and allows the RMD to be rolled with the other eligible assets, the RMD for the 401(k) will still be due, as will the RMD for the traditional IRA. The IRS does not give specific guidance on this, but some experts advise that, in order to truly satisfy the RMD from the 401(k) plan, the RMD amount must be put back into the 401(k) plan and then withdrawn.

Common error: I have a Roth 401(k) or 403(b), and just like my Roth IRA, I don’t need to take RMDs.

What the rules say: One of the more puzzling rules regarding RMDs is the fact that Roth 401(k) and Roth 403(b) plans both have RMDs. This is after-tax money, so the RMD does not increase your tax burden like a distribution from a traditional IRA would, but it can be a nuisance because, if you miss taking it, you will incur a 50% penalty. It may be smart to roll over these designated Roth accounts into a Roth IRA prior to the date you must start taking RMDs. Be aware, however, that if an RMD is due, that portion of the account balance is ineligible for rollover.

Common error: As long as I am still working, I can delay RMDs from my 401(k) or 403(b) past age 70½; I don’t have to start taking them until the year I in which I retire.

What the rules say: It is true that participants in 401(k) or 403(b) plans who are still working after age 70½ may delay their RMDs from those accounts until the year in which they retire. There is, however, one caveat: If you own 5% or more of the company by which you are employed, you lose the ability to delay RMDs. Even though you might still be working after age 70½, the IRS requires you to start taking RMDs by age 70½.

Please note: The exception for delaying RMDs only applies to qualified plans. Participants who also have traditional, SEP-, or SIMPLE IRAs are always required to start taking RMDs from those accounts by age 70½.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Investors should consult a tax preparer, professional tax advisor, or a lawyer.