Understanding required minimum distributions

Created date

September 21st, 2016
Individual Retirement Accounts

There are 639,000 U.S. taxpayers with IRAs worth over $40 billion who may not have taken required minimum distributions (RMDs) in 2012, according to a 2014 audit by the Treasury Inspector General for Tax Administration. Penalties are stiff for missing RMDs—potentially 50% of the missed distribution. 

“The IRS is taking an education and self-correction plan for now, but enforcement actions may be in the works,” says Pennsylvania C.P.A. Randy Tarpey (hksickler.com). 

Oregon investment advisor Gary Duell (garyduell.com) says virtually all tax-deferred retirement accounts, including IRAs, 401(k)s, TSAs, and 403(b)s, are subject to RMDs. You must begin taking RMDs by April 1 the year after you turn 70½.

“But if you wait until the following year, you will have to make withdrawals for both years, which may defeat tax-planning strategies,” Duell says.

The IRS provides tables to help calculate RMDs based on the balances in your accounts. Duell says RMDs are calculated to ensure that most funds are withdrawn by the time people reach age 115.

“The year you turn 70½, the RMD factor is 27.4,” he says. “So if your IRA balance at the end of the previous year was $100,000, you must withdraw $3,649.63, or $100,000 divided by 27.4.” 


There are few ways to avoid RMDs. Duell says there is a complicated exception for people with spouses at least ten years younger and a so-called stretch option that allows you to stretch RMDs over the lifetime of a beneficiary, such as a child. Another notable exception, says New Jersey wealth advisor James Ciprich (regentatlantic.com), exists for older business owners.

“If an investor is still working at 70 ½ and is a participant in a 401(k), they can defer their RMD on that account balance until retirement if they meet certain criteria related to ownership of the business,” Ciprich says. 

Careful planning with a trusted advisor can go a long way in minimizing the associated tax liability. For example, Duell says you could retire at age 65 and live off of nonretirement account savings.

“[Then] you could make IRA withdrawals of up to $16,350 [standard deduction of $12,400 plus personal exemption of $3,950—two personal exemptions if you’re married],” Duell says. “So over five years, a married person could withdraw tax-free over $100,000 that has never been taxed.”

Tarpey says a recent change now permits people to transfer up to $100,000 annually from retirement accounts to qualified charities—a strategy for philanthropists to consider. There are also new IRS rules for longevity annuities in IRAs. 

“RMDs related to annuities in IRAs have unique calculations, and a longevity annuity can lower RMD withdrawals annually based on its unique method of calculation of the RMD,” Tarpey says.

If you expect to be in a lower tax bracket because of reduced income or large deductions, Atlanta financial planner Rebecca Pavese (palisadeshudson.com) says to consider taking more than your RMD to minimize taxes. She also says you can take distributions as securities instead of cash, which allows you to take advantage of lower long-term capital gains rates.

“If your shares appreciate to, say, $10,000 and you sell them five years from now, you’ll get the capital gains rate,” Pavese says. “But if you kept them in the plan, that $5,000 gain would eventually be taxed at higher, ordinary income tax rates when the money’s withdrawn.”