Required minimum distributions beginning in 2020

Required minimum distribution (RMD) is the minimum amount that U.S. tax laws require to be withdrawn by participants every year. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in late December 2019, changed the retirement age at which RMDs are required from 70½ to 72 years for individuals who will reach age 70½ after December 31, 2019.

In general, if a participant reached the age of 70½ in 2019, the prior rule applies and the participant must take the first RMD by April 1, 2020. If the participant reaches age 70½ in 2020 or later, the first RMD must be taken by April 1 of the year after reaching 72. For all subsequent years, including the year in which the participant was paid the first RMD by April 1, the RMD must be taken by December 31 of that year.

Participants should remember that if they are active and participating in a retirement plan sponsored by their employers and don’t own more than 5% of the company, RMDs typically do not apply to that particular account until they retire. However, there could be exceptions to this rule for plans that require RMDs for active participants based on age only or for participants who die before RMDs begin.

The RMD age change should not be confused with a change in the latest Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act waives RMDs during 2020 for individual retirement accounts (IRAs) and retirement plans, including beneficiaries with inherited accounts. This waiver also includes RMDs for individuals who turned 70½ in 2019 and took their first RMD in 2020.

RMDs were introduced so that participants wouldn’t be able to avoid paying taxes forever. They would have to withdraw from their accounts or else they could face a penalty. Failure to take RMDs on time could result in a 50% tax penalty. In other words, the plan participant who should have received the RMD is liable for an excise tax under Internal Revenue Code Section 4974 equal to 50% of the amount of the RMD not received. Also, the plan sponsor could face plan disqualification—that means the plan loses its tax-exempt status and the many advantages that come along with that status. 

There are some positives that come with this retirement age change:

  • People can plan their taxes in a better way. They can defer taxes on any income and gains that the assets in their retirement accounts will generate. This will let their savings sit for a longer time.
  • People can minimize their annual tax impacts.
  • People can reap benefits due to the delay in forced distribution or mandatory distribution. In other words, they don’t need to worry about the reinvestment of an unwanted RMD amount, and this means no depletion of their account.
  • People who have sizable retirement account balances will find the later RMDs attractive because they don’t have to withdraw their money.
  • People can easily remember their time of RMD withdrawals. Calculation of RMD becomes simpler because no one has to track the 70½ age marker. Instead, they just have to wait for their 72nd birthday to be RMD-eligible.

However, there are also some items to note about RMDs and the change in RMD age:  

For participants:

  • People can face alternate tax withholding requirements if they withdraw more than what is required due to the RMD age change. They are required to pay 20% withholding in federal income tax on the amount above the RMD. The only way to avoid this tax on the overage is to roll over the excess to another qualified retirement plan or IRA. Therefore, this age change isn’t happy news for people who might have to withdraw more than required.
  • People’s retirement funds can be affected if they make changes in their lifestyle spending. Making those changes can seem attractive, and people may even consider it a good decision. But this can affect retirement planning and funds if not handled wisely. A delay in RMD could lead to changes in retirement planning, which might further lead to changes in lifestyle spending.

For plan sponsors:

  • Plan procedures need to be changed. Various forms and letters describing details of participants’ RMDs are sent to them every year. These plan procedures need to be updated so that they have the correct RMD information. In simple terms, all documents and procedures related to the plan need to be amended. Failure to update the documents may result in penalties and plan disqualification.
  • Participants must be given notices in a timely manner.  Once all the documents are updated, it’s the employer’s responsibility to ensure the participants receive information in a timely fashion to avoid any penalty. If the new rules are not properly implemented, it could result in plan administration errors. Employers and sponsors should work with administrators to ensure proper handling to avoid any such delays or errors. They must take care of errors while calculating the RMDs such as missing accounts, using the wrong balance, incorrect Internal Revenue Service (IRS) tables, incorrect ages, or missing RMD altogether.  Advisers also need to review their technology and planning processes and change them accordingly if needed. These mistakes may seem common, but they bring huge penalties if not corrected quickly.

Ultimately, the change in the RMD starting age won’t affect the population that is  already taking the RMD and will continue doing so regardless of their age. But one cannot ignore the fact that, while the RMD age change might seem small, it will bring lots of changes in paperwork and retirement income planning for people who are affected.