RMD- Avoiding the Plague

RMD and Black DeathRMD- Required Minimum Distribution

Small transgressions can come with enormous repercussions. Take for example the ‘black death’ pandemic of the 14th century. Tiny rodents were primarily responsible for wiping out nearly 200 million people of the European population because of the bacteria-carrying fleas that hitched rides on rat’s backs. While failure to take a required minimum distribution may not be as threatening, the consequences for not taking one can plague the plan sponsor, the participant, and the plan. This post will clarify who is required to take an RMD, when they must do so, and the consequences for failing to.

After years of a participant stowing away money into a tax-deferred retirement plan, there comes a time when the IRS wants to collect their share of taxes. For this reason, the federal government requires that an RMD must be taken once certain participants reach age 70 1/2 in order for the IRS to collect taxes on applicable balances.

Who must take an RMD:

  1. A participant who is a 5% owner of the company, still employed, and age 70 1/2 is required to take an RMD.
  2. A retired participant who is age 70 1/2 is required to take an RMD.

A participant who is 70 1/2 and still employed and NOT a 5% owner does NOT have to take an RMD.

When must the first RMD be taken?

A participant will have until April 1st of the year following the year in which they turn 70 1/2 to take their first RMD.

Example 1: If John turns 70 on June 5, 2014 he will be 70 1/2 on December 5, 2014. John would be required to take his minimum distribution by April 1, 2015.

Example 2: If Suzy turns 70 on July 1, 2014 she will be 70 1/2 on January 1, 2015. Suzy won’t have to take an RMD until April 1, 2016.

When must subsequent RMD’S be taken?

Once a participant has taken their first RMD, they must continue to take subsequent RMD’s annually by December 31st of each year. Depending on when the participant takes their first RMD, they may be required to make 2 withdrawals their first year.

Example: If Suzy takes her first RMD on April 1, 2016, she will have to take her second RMD on December 31, 2016. Thereafter, Suzy would take subsequent RMD’s once per year by December 31.

Tax Tip: To avoid having both of these amounts included on the participant’s income for the same year, they can make their first withdrawal by December 31 of the year they turn 70 1/2 instead of waiting until April 1 of the following year.

Which plans require an RMD?

Profit Sharing, 401(k), 403(b), 457(b) plans, traditional IRAs, SEPs, SARSEPs, and SIMPLE IRAs. These rules also apply to Roth 401(k) accounts but not while the IRA owner is alive.

What if a participant fails to take an RMD?

If the participant fails to withdraw the RMD, a portion of the RMD, or make a timely withdrawal, then they can be penalized with a 50% excise tax on the amount not distributed as required.

Can a participant age 70 1/2 who is still employed and taking an RMD continue to make salary deferrals to the plan?

Yes, unless otherwise stated in the plan document.

Is the plan sponsor required to make contributions to employees over 70 1/2 receiving RMD’s?

Yes. Otherwise, the plan may lose its qualified status.

Operating a non-compliant plan can be a nightmare for plan sponsors and a participant giving up half of their retirement money for failure to take a timely distribution can be even more frightening. Work with your third party administrator, financial advisor, and fund company to ensure your plan’s compliance.

For additional information about Required Minimum Distributions from Retirement plans, you can visit the IRS’s website here. Feel free to leave your questions in the comments below.

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