Outside-IN

100% required minimum distributions

In some cases, the RMD is the entire IRA balance — or more!

Mar 6, 2019 @ 5:02 pm

By Ed Slott

Can it ever be the case that an individual retirement account's required minimum distribution, or RMD, for a year equals the entire IRA balance? Yes, but that only happens if there is no designated beneficiary.

A designated beneficiary means an individual beneficiary named on the IRA beneficiary form. Often there is no designated beneficiary, either because no beneficiary was named on the beneficiary form or the named beneficiary is not an individual but instead is an estate, charity or non-qualifying trust.

Even if the IRA eventually goes to an individual beneficiary, if it gets to that beneficiary through the estate for example, then there is no designated beneficiary.

The 100% RMD occurs when there is no designated beneficiary and the IRA owner died before his or her required beginning date (April 1 of the year following the year the IRA owner reaches age 70½).

In that case, the entire inherited IRA must be paid out under the so-called "five-year rule," which says an IRA must be withdrawn in full by the end of the fifth year after the year of the owner's death. Unlike a stretch IRA, where withdrawals are taken ratably over many years, under the five-year rule no distributions are required during the first through fourth years after the owner's death. But whatever is left in the inherited IRA in the fifth year must all be withdrawn in that year. In this case, the fifth year RMD is 100% of the account balance, and that RMD will be taxable all in one year (unless this is an inherited Roth IRA).

(More: 5 costly inherited IRA mistakes)

Example

Josie never named a beneficiary on her IRA, so when she died in 2013 at age 65, her estate became her beneficiary by default.

Because the estate was the beneficiary and Josie died before her required beginning date, the five-year rule applied. This means that Josie's entire IRA had to be emptied by Dec. 31, 2018.

Josie's will named her two sons, Len and Ben, as co-executors of her estate. Len and Ben never got along and they fight about everything. As a result, in 2019, Josie's IRA is still sitting there. The estate will owe the 50% penalty for 2018 on the total balance of Josie's IRA for 2018 because that was the year the RMD was 100% of the IRA. If Len and Ben do not take a total distribution in 2019, the 50% penalty will apply for that year too and for every year the RMD — the total amount in the IRA — remains undistributed.

If the beneficiary neglects the 100% RMD for even a few years, the 50% penalty can actually exceed the amount of the total IRA balance, leaving the beneficiary with a growing tax debt instead of an expected inheritance, especially when you add in the mounting penalties and interest. Advisers need to react quickly to recognize the problem and to have these RMD penalties waived.

To have the penalty waived, the beneficiary must take the missed RMD and then file Form 5329 (Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts) to request a penalty waiver. The form must be filed for each year there was a missed RMD. There is no statute of limitations if this form is not filed, so the 50% penalty will never go away unless the waiver is requested.

(More: A younger spouse can lower required minimum distributions)

Roth IRA Trap

This 100% RMD situation hits inherited Roth IRAs harder. When there is no designated beneficiary on a Roth IRA, the inherited Roth funds will always be subject to the five-year rule, no matter when the Roth IRA owner died.

Roth IRA owners are not subject to RMDs during their lifetime so there is no required beginning date for a Roth owner. This means that whenever a Roth IRA owner dies without a designated beneficiary, that inherited Roth will be subject to the five-year rule. That can put a real damper on the tax-free growth for the beneficiary.

The 100% RMD will be tough for an adviser to explain to a beneficiary when this outcome could be avoided just by checking IRA beneficiary forms to make sure intended beneficiaries are named.

(More: Were any required minimum distributions missed last year?)

For more information on Ed Slott, Ed Slott's 2-Day IRA Workshop and Ed Slott's Elite IRA Advisor Group, please visit www.IRAhelp.com.

0
Comments

What do you think?

View comments

Upcoming event

Sep 24

Conference

Diversity & Inclusion Awards

Attend an event celebrating diversity and inclusion as well as recognizing those who are leading the financial services profession in this important endeavor. Join InvestmentNews, as we strive to raise awareness, educate and inspire an... Learn more

Most watched

Events

Jim Crowley, a new sheriff in town?

BNY Mellon Pershing's new CEO as of July 1st, Jim Crowley, discusses his vision for the future of the company.

INTV

How the 2020 elections could impact ESG investing

Joseph Keefe, president of Impax Asset Management, on the elections and how advisers can build a bridge to the next generation of clients with ESG investing.

Latest news & opinion

Departure of Alexander Acosta could slow DOL effort to revise fiduciary rule

Acting secretary Patrick Pizzella will have to make political decision to move ahead.

SEC member Peirce to brokers: Talk to us early, often about Reg BI implementation problems

She's willing to advocate for additional compliance time if firms have made a good faith effort.

Hub in talks to buy $40 billion LPL branch Global Retirement Partners

GRP, an LPL super-OSJ, would represent the latest in a flurry of acquisitions for Hub.

David Lerner Associates' financial condition deteriorates

Firm reported 'negative net worth' of $17 million last year in recent SEC filing.

Why healthy clients need to save more for retirement

Tax-free health savings accounts, Roth IRAs, insurance and annuities can help cover retirees' future health-care costs.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print