Required Minimum Distributions

In prior posts I have extolled the benefits of the tax exemption of tax-favored retirement accounts. But all good things must end, and so must tax-exemption.

For many people, the end of tax exemption is determined by their need for cash from their retirement accounts to meet their living expenses. To spend it, you’ve gotta’ take it out of the plan. But some have other resources to live on, in which case the end of tax exemption can be determined by the Required Minimum Distribution rules. In today’s post, I will briefly describe those rules as they apply during your lifetime. (Post-death Required Minimum Distribution rules will be described in a later post.)

At the outset it’s important to recognize that Roth IRA’s are not subject to Required Minimum Distributions during your lifetime—a significant benefit which will be explored in a later post. Roth 401(k) accounts are theoretically subject to lifetime Required Minimum Distribution rules, but you can easily get around them by taking a lump sum distribution from your Roth 401(k) account, and rolling it over to a Roth IRA, which is not. So the rules described today are effectively limited to traditional tax-favored retirement accounts.

Another thing. Congress suspended Required Minimum Distributions for 2009 in light of people’s unusual market losses, so you don’t need to take a distribution this year if you don’t want.

Generally, you must begin taking retirement account distributions the year you reach age 70-1/2. (There’s that half-birthday thing again. Who came up with that?) However, in the case of an employer plan, such as a 401(k) plan, you can further delay the start of distributions until you actually retire from the sponsoring employer. Unless you own 5% or more of the employer, in which case, 70-1/2 is it.

You can also delay your first year’s distribution and take it early the second year—by April 1. But that particular delay is only allowed for the first year’s Required Minimum Distribution. So if you take advantage of it you’ll be forced to double up on distributions in the second year.

So how much must you distribute once you’ve reached the magic year? A few years ago the rules were criminally complex, but the IRS stepped up and simplified them greatly. The usual rule (with one exception to be described below) is simply this: Divide the value of your account (as of January 1; actually, the prior December 31 will do) by the Applicable Distribution Period, based on the age you will attain during the year. The Applicable Distribution Period can be found in a table the IRS has created, which is printed as an appendix in IRS Publication 590. It's called Table III, Uniform Lifetime Table.

As I said, there is one possible exception to the above procedure: If you are married to a much younger spouse and you have named your spouse as your death beneficiary under the plan. Then you may skip the Uniform Table and use your and your spouse’s joint life expectancy, which can also be found in an appendix in IRS Publication 590. This generally gives you a higher divisor, and therefore a lower Required Minimum Distribution, if your spouse is 10 or more years younger than you. Yet another reason to marry a young’un.

To make it even simpler, the institution that serves as custodian of your IRA is required to inform you of the amount of your Required Minimum Distribution each year.

If you have more than one traditional IRA, you are permitted to aggregate your Required Minimum Distributions and take them from whichever IRA you please. But you can’t do that with employer plans. Each employer plan must separately meet its Required Minimum Distribution obligation.

So those are the rules. That's how tax exemption ends, not in a lump sum, but in an annual dribble. In another post I will discuss how you can use them to your advantage.