Required Minimum Distribution Rules

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Required Minimum Distributions WARNING:  It is mandatory to read the update on the Required Distribution Rules  Reading the Contents and Alerts pages are also necessary actions before you make decisions or computations.

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Determining When to Start the Distributions

Required Minimum Distribution Rules require the owner of a traditional IRA to begin taking minimum distributions at the age 70¹/₂ year. You are 70¹/₂ six months after your 70^th birthday. When is your age 70¹/₂ year? This depends on the month of your birthday. If you turn 70:

• Jan. through June: that same calendar year is your age 70¹/₂ year.
• July through Dec.: the year after will be your age 70¹/₂ year.

Once the owner reaches the age 70¹/₂ year, s/he must make a Required Minimum Distribution. The distribution amount is the IRA balance from January 1 of the 70.5 year (before the opening of business and before any transactions occur) divided by an IRS approved measure of life expectancy.

Calculating The Required Minimum Distribution

Significance of the Required Beginning Date

Enactment of the distribution rules also depends on whether you have reached the Required Beginning Date. This is April 1 of the calendar year following the year you reached age 70¹/₂ . If you die on or after this date, elections you have or haven’t made up to that point will determine how your traditional IRA will be distributed. These distributions are generally "locked in," so they won’t change unless you or a beneficiary die, or unless they are rolled over by a surviving spouse.

You must begin making annual distributions once your reach the age 70¹/₂ year. A one-time exception applying only to the first year is a rule that allows you to delay your first distribution until April 1 of the year following the age 70¹/₂ year. Watch the tax consequences of delaying that first distribution, though. You will still be required to take a distribution for that year as well, so postponing your first distribution could push you into a higher tax bracket.

You should consult IRS Publication 590: Individual Retirement Arrangements if you have further questions.

Maximizing Deferrals

The following distributions are permissible"

1. Lump Sum

2. Ratably equal amounts over the owner's life

3. Ratably equal amounts over the owner's life and that of the beneficiary

The IRS has prescribed tables for determining the number of years to use.  The IRA owner who did not designate a beneficiary, or is treated as not having a designated beneficiary has no choice - the owner's life must be used.

Next - there is a choice.  The owner may choose between two methods to calculate the non-annuity type required minimum distribution as follows:

• Term Certain Method  The first required minimum distribution is found by dividing the IRA balance at the end of the previous year by the expected "return multiple" for the IRA owner's attained age as of his or her birthday in the calendar year in which s/he attains 70 1/2 - or

• Recalculation Method  The first required distribution is found using the same method as the Term Certain Method.  The IRA balance at the end of the previous year is divided by the expected return multiple (life expectancy) for the IRA owner's age as of his or her last birthday in the calendar year in which he or she attains age 70 1/2.  The required minimum distributions for each succeeding year are found by dividing the IRA balance as of the end of the year preceding the distribution year by the IRA owner's life expectancy in each distribution year using his or her attained age of his or her birthday in that distribution calendar year.  Thereby the amount of the distribution will be different each year, and usually this results in a longer deferral.

If the life of the owner and a beneficiary are used the following choices are available:

• Term Certain method over both life expectancies;

• Recalculation Method of both life expectancies, or

• Recalculation of the IRA owner's life alone

If the beneficiary is not the spouse of the owner, then the age difference must be computed and the following rules followed.

If the difference is not more than ten years, the following calculation methods can be used:

• the IRA owner's life alone using either the Term Certain or the Recalculation Method;

• the joint and last survivor expectancies of the owner and the beneficiary, using the term certain method, or

• the joint and last survivor expectancies of the owner and the beneficiary, using the recalculation method, but only the account owner's life expectancy, not the beneficiary's may be recalculated.

What if the age differential is more than ten years?  Required Distributions from an IRA during the owner's lifetime must satisfy the minimum distribution incidental benefit (MDIB) requirement if the designated beneficiary -

1. is someone other than the owner's spouse and

2. is more than ten years younger than the account owner.

This MDIB requirement essentially provides that where the spouse is not the designated beneficiary, the amount of the payments to be made to the owner before passing on must be determined under the principles of the minimum required distribution rules  as though there is not more than ten years difference.

What if there are multiple beneficiaries?  The designated beneficiary with the shortest life expectancy is the designated beneficiary for the purposes of computing the required minimum distributions.

What if one of the designated beneficiaries is not an individual?  The owner is treated as having no designated beneficiary.  This rule applies even if all but one of the beneficiaries are individuals.

The planning for the distributions should be completed before reaching the required minimum distribution age.

Warning

If minimum distributions are not taken as required, the IRS charges a penalty equal to 50 percent of the amount that was not taken.

Other Thoughts Covered in Separate Pages:

• Future tax tips will discuss other aspects of decisions about IRA accounts:
• Circumstances where the IRA owner passes on in the 70.5 year, but the distributions had not commenced
• Designating spousal and non-spousal beneficiaries
• Balances left in the Estate
• Early distribution penalties and exceptions

Remedies For The 50% Penalty

The following is an excerpt from the tax code pertaining to the potential penalty for a failure to take a minimum required distribution:

“4974(d)  Waiver Of Tax In Certain Cases If the taxpayer establishes to the satisfaction of the Secretary that--

4974(d)(1)   the shortfall described in subsection (a) in the amount distributed during any taxable year was due to reasonable error, and

4974(d)(2)   reasonable steps are being taken to remedy the shortfall, the Secretary may waive the tax imposed by subsection (a) for the taxable year.

(Added Pub. L. 93-406, title II, 2002(e), Sept. 2, 1974, 88 Stat. 967, and amended Pub. L. 94-455, title XIX, 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834; Pub. L. 95-600, title I, 157(i)(1), Nov. 6, 1978, 92 Stat. 2808; Pub. L. 99-514, title XI, 1121(a)(1), title XVIII, 1852(a)(7)(B), (C), Oct. 22, 1986, 100 Stat. 2464, 2866.)”

What that means:

Waiver ~ The tax may be waived if you establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. If you believe you qualify for this relief, you must file Form 5329, pay the tax, and attach a letter of explanation. If the IRS grants your request, the tax will be refunded.

The taxpayer’s accountant should make the claim for the waiver of the penalty or surtax and inform both the registered representative and the taxpayer, of the remedies the statute provides for the abatement of the penalty.

The excise tax can be waived by the IRS if the recipient shows that the shortfall in distributions was due to reasonable error and that steps are being taken to remedy the error. Code Section 4974(d) and Prop. Reg. Section 54.4974-2, Q&A 8.

TIP: In applying for the waiver, the instructions to Internal Revenue Service Form 5329 state that the excise tax should be calculated, the amount paid, and a statement of explanation attached with the return. If the IRS rules favorably on the request, the instructions state that a refund check will be issued.

§54.4974-2 affirms this by restating the Code in the Internal Revenue Service promulgation, in Q&A #8:

Q-8. Are there any circumstances when the excise tax under section 4974 for a taxable year may be waived?

A. The tax under section 4974(a) may be waived if the payee described in section 4974(a) establishes to the satisfaction of the Commissioner the following:

(a) The shortfall described in section 4974(a) in the amount      distributed in any taxable year as due to reasonable error, and

(b) Reasonable steps are being taken to remedy the shortfall.

This research, although not exhibiting an exhaustive list of reasons the Internal Revenue Service might consider as reasonable cause, should establish the authority to request a waiver of the penalty.