As more clients reach age 70 ½, as the first baby-boomer did on January 1, 2016, advisors will be receiving more calls from clients about taking required minimum distributions (RMDs) from IRAs and other retirement accounts. Get it right the first time and avoid these common errors.
1. Not taking all retirement accounts subject to RMDs into account
Clients often have several IRAs or plans. Make sure that they have taken all of those balances into account for calculating RMDs. In addition, they may have inherited IRAs that are subject RMDs.
You need to have a complete inventory of accounts subject to RMDs. There is a 50 percent penalty for not taking an RMD, although the penalty can be waived for good reason by filing Form 5329 with IRS and explaining that the client made an honest mistake, was confused or ill, or received incorrect information from the financial institution or advisor.
The 50 percent penalty also applies to missed RMDs from inherited IRAs and inherited Roth IRAs.
2. Getting confused about first-year RMDs
First-year RMDs are overwhelming for some clients. A common error is using the wrong balance for the first RMD. RMDs begin for the year a client reaches age 70 ½.
Use the December 31st balance of the year before the first required distribution year, even if the actual first RMD is not taken in that year. For the first year, the law gives people until April 1st of the next year to take their first RMD.
For example, if Jim turned 70 ½ at any time in 2015, his required beginning date (RBD) is April 1, 2016. If Jim elects to take his first RMD in March 2016, he still must use the December 31, 2014 IRA balance to calculate his first year RMD, since that is the year-end balance the year before his 70 ½ year (2015).
3. Committing aggregation errors
When clients have multiple IRAs or company plans subject to RMDs, make sure they take their RMDs from the right plan or IRA. For example, you cannot satisfy an IRA RMD from a 401(k), and vice-versa.
However, IRAs have a special aggregation rule that allows RMDs from IRAs (including SEP and SIMPLE IRAs) to be taken from any one or combination of those IRAs. 403(b) plans have the same aggregation rule.
But you cannot satisfy a 403(b) RMD from an IRA and vice versa. You also cannot satisfy an IRA RMD from an inherited IRA.
Inherited IRAs inherited from the same person can be aggregated for calculating RMDs, but RMDs for IRAs inherited from different people cannot be aggregated. They must be calculated and taken separately.
A husband and wife who each have IRAs and are each subject to RMDs must take those RMDs separately from their own IRAs. For example, a husband cannot satisfy his RMD from his wife’s IRA and vice-versa even though the total RMD for both will be reported on the same joint tax return.
4. “Still working” exception mistakes
A special exception to RMDs applies to those who are still working for a company, but this exception never applies to IRAs or to other plans of companies the employee no longer works for. The exception allows employees to delay RMDs until the year after they retire.