Approximately 10,000 “baby boomers” are turning age 70.5 every day. Many of these individuals own qualified retirement accounts including 401(k) and 403(b) plans, the Thrift Savings Plan (TSP), and traditional IRAs. Now that they have reached their 70.5th birthday, they must withdraw a required minimum distribution (RMD) annually from each of these accounts.
Knowing the RMD rules is extremely important because of the severe IRS penalties for failing to receive the correct amount of the RMD. This column discusses common RMD mistakes to avoid. In reality, the topic of RMD is one of the simplest areas in the Internal Revenue Code to understand. But as simple as it is, RMDs seem to generate many mistakes as well as failures to take advantage of some planning opportunities.
The following are three common RMD pitfalls:
1. Deferring RMDs one year too late
The rule is that individuals must begin taking annual RMDs from their qualified retirement plans and traditional IRAs starting the year they become age 70.5. But some individuals can defer taking their RMDs, such as federal employees who work past age 70.5 in federal service and who are participating in the TSP. Federal employees working past age 70.5 can delay the start of their TSP RMDs until they retire from federal service. But if these same individual own other retirement accounts that they previously participated in including 401(k) or 403(b) retirement plans, and/or traditional IRAs, they must take annual RMDs from each of these retirement accounts starting the year they become age 70.5. The following example illustrates:
Chris, age 68, is a federal employee and contributes to the TSP. Chris also owns traditional IRAs and has several thousands of dollars in his 401(k) that he previously contributed to when he worked for a private company. Stating in the year Chris becomes age 70.5, he will have to take annual RMDs from his traditional IRAs and his 401(k) plan. But he will not have to take RMDS from his TSP if he continues working in federal service past his 70th birthday. He will start taking RMD from his TSP immediately after retiring from federal service.
If Chris were to transfer all of his traditional IRAs and his 401(k) retirement plan assets into his TSP, then starting at age 70.5 he would not have to take RMDs from his IRAs and 401(k) plan because these retirement assets are contained within the TSP. Until he retires from federal service – no matter what age past 70.5 – Chris can defer taking RMDS from his TSP.
But timing is the key for transferring traditional IRA and qualified retirement plan assets into the TSP. No later than the year individuals become age 69.5 – not age 70.5 – is the last year individuals can roll money into the TSP without worrying about RMDS until they retire from federal service.
If the direct rollover or transfer into the employee’s TSP account were done too late; namely, in the year the employee becomes age 70.5, then the employee would have to take the RMDs for the traditional IRAs and the qualified retirement plans for the first year (age 70.5) and only then can a direct rollover or transfer the IRA and qualified retirement plan assets into the TSP result in avoiding RMDs until the employee retires from federal service.
2. Taking from the wrong accounts to satisfy the required minimum distribution
In general, individuals do not have a choice when it comes to RMDS and the accounts to withdraw from. For example, if a federal annuitant has a TSP account, traditional IRAs and a 401(k) account, then the annuitant would have to take a RMD from all three account rather aggregating the account balances from the three and taking one RMD. The exception is when an individual owns multiple traditional IRAs. In that case, the IRA owner can aggregate the RMD based on the total account balance of all traditional IRAs and withdraw the RMD from an IRA of his or her choice. In other words, a RMD need not be taken from each IRA.
Note that inherited (or “death”) IRAs are not included in this equation. An individual cannot mix inherited IRAs with personal IRAs for the purpose of fulfilling RMDs. Inherited IRAs have their own separate RMDs
3. Not taking advantage of qualified charitable distributions (QCD)
QCDs became a permanent part of the Internal Revenue Code at the end of 2015. Individuals age 70.5 and older can use QCDs to satisfy all or part of the RMD from a traditional IRA. With a QCD, an individual age 70.5 and older transfer a portion of his or her traditional IRA directly to a qualified charity. If the amount of the transfer is at least as large as the RMD for that plan, then the individual has satisfied his or her requirement for that year.
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- The individual’s taxable income will not be reduced for that year resulting in no tax savings;
- the QCD is not included as a charitable contribution for the year that the person itemizes, also resulting in no tax savings associated with the QCD;
- normally, in order to fulfill a RMD, an individual must request an IRA withdrawal which is at least partially taxable. A RMD satisfied through a QCD is not included in the IRA owner’s income perhaps resulting in the IRA owner paying less in monthly premiums for Medicare Part B which is “means” tested; and (4) a TSP RMD cannot be satisfied through a QCD. If a retired TSP participant intends to satisfy TSP RMDs through a QCD, then the TSP participant would have to directly transfer his or her entire traditional TSP account to a traditional IRA. This would ideally be done before the TSP participant reaches the year he or she becomes age 70.5.