For many physicians the term "required minimum distributions" remains a mystery. However, it is critical that physicians pay attention to RMDs - overlooking the rules can be costly.
Many of my physician clients have heard of required minimum distributions (RMDs), but for many the term remains a mystery and the process is often confusing. However, it is critical that physicians pay attention to RMDs — overlooking the rules around their RMD can be costly.
Here are some of the most frequently asked questions from my clients on this topic:
What are Required Minimum Distributions?
In a nutshell, RMDs are the minimum amount that the government requires you to withdraw each year after a certain age. These distributions are the government's way of taxing retirement accounts that had tax-deferred growth for many years, thereby allowing the government to collect the revenue on the withdrawals.
What types of retirement accounts have RMDs?
RMDs apply to any retirement account, including individual retirement accounts (IRAs) and also employer-sponsored plans, such as 401(k)s and 403(b)s.
In the case of IRAs, the first required minimum distribution must be taken for the year you turn 70-and-a-half, but you may delay receiving it until April 1 of the following year. So, if you turn 70-and-a-half in 2013, you can delay taking your first RMD until April 1, 2014. The second RMD for the year 2014 would need to be taken by Dec. 31, 2014, resulting in two RMDs in the same tax year. For all subsequent years, the deadline for taking your RMD is Dec. 31 of that year.
The same rules apply for employer-sponsored plans like 401(k)s and 403(b)s, but you can delay starting the RMD from your current employer’s retirement plan if you are actively employed and own less than 5% of the company or practice.
RMDs are taxed at the income tax rate of the owner.
Why do physicians need to be concerned about RMDs?
The main reason RMDs may cause concern is that there is a severe penalty for not taking your RMD on time. The amount not withdrawn is subject to a penalty of 50%. For example, if your RMD for a given year is $60,000 and you fail to take it by the deadline, you will still have to withdraw the required distribution of $60,000 and pay the tax due on that amount, but there will also be a $30,000 penalty at that time.
Are there any exceptions to taking your RMD?
Yes, there are two main exceptions. One is the retirement plan exemption mentioned above. If you continue to work after age 70-and-a-half and do not own more than 5% of the company you work for, you can delay taking RMDs from 401(k)s or 403(b)s of that employer until April 1 of the year after the year in which you retire.
The second is Roth IRAs. You are not required to take minimum distributions from a Roth IRA during your lifetime. This is part of the reason that Roth IRAs are such a powerful planning tool as the money in a Roth IRA can continue to grow tax-free and not have to be withdrawn and income tax paid.
The exemption from withdrawing an RMD from the employer-sponsored plan of your current employer can offer an interesting planning opportunity. By rolling any other employer accounts and IRAs into the employer-sponsored account at your current company, you can avoid taking RMDs until retirement age, whenever that is for you.
One thing to consider when executing this strategy is that most employer retirement plans do not allow a great deal of flexibility in investment choices. As well, many plans do not allow sufficient flexibility in beneficiary designations complicating proper estate planning. Because of these factors, a strategy of rolling all of your retirement money to your current employer’s plan to avoid the RMD is usually not advisable.
How are RMDs calculated?
Take the balance of the tax-deferred account as of Dec. 31 of the prior year and divide it by the life expectancy factor from the IRS Uniform Lifetime table.
Life Expectancy Factor
1. Tax-deferred account balance on Dec. 31 of the previous year $750,000
2. Life Expectancy Factor for your age on your birthday this year 27.4
3. Line 1 divided by line 2 = RMD for this year $27,372.26
Note: If your spouse is more than 10 years younger and is the sole beneficiary of the retirement account, you will need a different calculation than the one above, so that age can be factored in appropriately.
In sum, with appropriate planning, you can manage for when, where and why to make your withdrawals. It’s never too early to discuss and prepare for RMDs of retirement accounts.
Joel Greenwald, MD, CFP, is a physician-turned financial planner who exclusively provides financial advice to doctors. He has written many articles and been a frequent speaker on how physicians and dentists can achieve long-term financial security. More about Joel Greenwald and his firm, Greenwald Wealth Management, can be found at www.joelgreenwald.com.
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