401 (k) News and Investing Fall 2021

The RMD rules apply to all employer-sponsored retirement plans, including:
• 401(k) plans
• Profit sharing plans
• Other defined contribution plans
• Traditional IRAs, SEPs, SARSEPs and SIMPLE-IRAs.

The RMD rules also apply to Roth 401(k) accounts. However, they don't apply to Roth IRAs while the original owner is alive. One way to avoid RMDs on your Roth 401(k) is to roll over the balance into your own Roth IRA.

After your death, however, beneficiaries of your Roth IRA must take RMDs under the same rules that apply to traditional IRAs. Because it's a Roth IRA, the distributions will be tax-free, if the rules for qualified withdrawals are met.

When Must I Start Taking RMDs? The SECURE Act pushed back the RBD to 72 for individuals who reach 70½ after 2019. For example, if you turned 70½ on January 1, 2021, you won't be 72 until July 1, 2022. So you can delay your first RMD until April 1, 2023.

When Must I Take RMDs in Succeeding Years? The deadline for taking subsequent RMDs is December 31 of the calendar year for which the RMD applies. Therefore, if you have to take your first RMD for the 2021 tax year by April 1, 2022, you must also take your RMD for the 2022 calendar year by December 31, 2022. To reduce overall tax liability, you might take the first RMD in 2021 instead of taking two RMDs in 2022.

How Do I Calculate the Annual RMD? Generally, you just divide the balance in the plan or IRA on December 31 of the prior year by the appropriate life expectancy factor. However, your company plan or IRA trustee or custodian will usually calculate annual RMD amounts for you. The IRS provides life expectancy tables for taxpayers to use to calculate RMDs.

Can I Withdraw More Than the Required Amount? There's no restriction against taking bigger-than-required distributions. You can take out as much as you want as long as you take at least the RMD amount for the calendar year.

Must I Take RMDs From All Qualified Plans and IRAs? You must calculate the RMD separately for each IRA you own. But you can withdraw the total amount from just one IRA or any combination of IRAs that you choose. The same rule applies to 403(b) plans. However, for all other qualified plans, the RMD must be taken separately from each plan account.

Will My Plan Administrator or IRA Trustee or Custodian Ensure that My RMD Is Made on Time? A plan administrator or IRA trustee or custodian may provide the information for you to calculate RMDs or do the calculation for you. But it's ultimately your responsibility to take the RMD for the applicable tax year.

How Much is the Penalty? Subtract any distributions that you took from the RMD amount that you should have taken. The RMD penalty equals 50% of that difference. If you make this same mistake for several years, the penalties will continue piling up until you start taking the proper RMD amounts. The penalty is in addition to any other income tax that you owe for the year. Penalties are the responsibility of the account owner, not the retirement plan or IRA trustee or custodian.

How Do I Estimate the Income Tax on an RMD? The taxable portion of any RMD is taxed at ordinary income rates. But any amount attributable to a return of basis in the account is tax free. As mentioned earlier, the RMD rules don't apply to an original Roth IRA owner (the person for whom the account was originally set up).

Are There Any Exceptions to the RMD Penalty? The penalty may be waived if you can show that the shortfall was due to reasonable error and you're taking steps to remedy it. Your tax advisor can help draft a letter of explanation and file the appropriate tax form to demonstrate why your situation qualifies for an exception.

Are RMDs Subject to the NIIT? Distributions from qualified retirement plans and IRAs aren't included in net investment income for purposes of the 3.8% net investment income tax (NIIT). However, RMDs will drive up your modified adjusted gross income, which could trigger or increase NIIT liability on your net investment income.

If I Take RMDs, Can I Still Contribute to a Qualified Employer Plan or IRA? RMDs don't affect your eligibility for contributions to qualified retirement plans. So, if an 80-year-old employee still works and participates in a qualified employer plan, his or her employer must make contributions on the individual's behalf and give the employee the option to continue making salary deferrals if the plan permits them. Otherwise, the employer's plan could lose its qualified status. Previously, you couldn't contribute to a traditional IRA after you turned 70½. However, the SECURE Act removes this limitation. For 2020 and thereafter, there's no age restriction. But you must have earned income that at least equals your contribution. There has never been any age restriction on Roth IRA contributions, but you must have earned income that at least equals your contribution.

Do I Have to Take RMDs If I'm Still Working? Generally, you must take RMDs from all qualified plans and traditional IRAs. However, you don't have to withdraw an RMD from your employer's qualified plan if you still work full-time for the employer and you don't own 5% or more of the company (attribution rules apply). There's no similar exception for traditional IRAs. In addition, you must still take RMDs from qualified plan accounts that you may still have at former employers. (That is, accounts that haven't been rolled over to your current employer's plan.)

Can I Roll Over an RMD to another IRA or Tax-Deferred Retirement Plan? Rollovers are strictly prohibited. Allowing retirees to roll over RMDs to other retirement accounts would defeat the purpose of the mandatory distribution rules.

Can I Donate RMDs to Charities? For IRAs, the answer is yes. The tax law allows you to annually transfer up to $100,000 directly from an IRA to an IRS-approved charity without paying tax on the distribution, and the distribution counts towards your RMD obligation for the year. However, you can't deduct the charitable contribution. If your spouse has an IRA set up in his or her own name, your spouse is entitled to a separate $100,000 limit.

What Happens If I Die Before RMDs Start? If you die before the RBD, no RMD is required for the year of death. For subsequent years, beneficiaries must take RMDs from inherited accounts. Under the SECURE Act, the account usually must be emptied out within 10 years, subject to exceptions for so-called "eligible designated beneficiaries," such as a beneficiary who is disabled or has not yet reached the legal age of majority. Also, the 10-year rule doesn't apply to beneficiaries of account owners who died before 2020.
Important: For an inherited account, a spousal beneficiary has greater flexibility than a non-spousal beneficiary, including being able to treat the inherited account as the spouse's own account.

What Happens If I Die after RMDs Start? If you die on or after the RBD, the beneficiary of the inherited account must take an RMD for the year that you passed away. The inherited account usually must be emptied out within ten years, subject to exceptions for spousal beneficiaries and eligible designated beneficiaries. Also, the 10-year rule doesn't apply to beneficiaries of account owners who died before 2020.

Important: The beneficiary of an inherited retirement account is exposed to the 50% penalty on any RMD shortfalls. If the retirement account owner dies midyear, the beneficiary may be unaware that the owner has passed away before taking his or her full RMD amount for the year.

Other complex RMD rules may apply if there are multiple non-spousal beneficiaries or if a trust is the beneficiary of a retirement account. Contact your tax professional for guidance if you inherit an IRA or other tax-favored retirement account. It's important to understand what you must do to avoid the punitive 50% penalty for failing to comply with the RMD rules.

If you're subject to the required minimum distribution (RMD) rules for 2021, you have until year end to figure out the amount. As long as you get the money by December 31, 2021, you're in the clear for this year.