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Required minimum distributions (RMDs) are minimum amounts that U.S. tax law requires one to withdraw annually from traditional IRAs and employer-sponsored retirement plans. In the Internal Revenue Code itself, the precise term is "minimum required distribution". [1] Retirement planners, tax practitioners, and publications of the Internal Revenue Service (IRS) often use the phrase "required minimum distribution".
Individuals with IRAs are required to begin withdrawing a minimum amount from their IRAs no later than April 1 of the year following the year in which they reach age 72. [lower-alpha 1] IRA owners do not have to take lifetime distributions from Roth IRAs, but after-death distributions (below) are required. They can always withdraw more than the minimum amount from their IRA or plan in any year, but if they withdraw less than the required minimum, they will be subject to a federal penalty. The monetary penalty is an excise tax equal to 50% of the amount they should have withdrawn, plus interest. [4] This penalty is in addition to the ordinary income tax assessed at the individual's marginal rate and any state income taxes.
The RMD rules are designed to spread out the distributions of one's entire interest in an IRA or plan account over one's life expectancy or the joint life expectancy of the individual and his or her beneficiaries. The purpose of the RMD rules is to ensure that people do not accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions force the holder to withdraw at least some of the funds as taxable distributions while still alive.
Unlike most distributions from IRAs and qualified plans, RMDs are never eligible for rollover; they must be withdrawn. Because the distributions are not rollover-eligible, however, taxes are not required to be withheld at the time of distribution, and may thus be postponed until the individual files a Federal income tax return for the year. Any amount withdrawn above the minimum required amount will be eligible for rollover within 60 days of the distribution. Income tax must be withheld from that portion if the rollover option is not elected.
Income tax is generally not due on any part of the RMD which is paid to a charity. These are called Qualified Charitable Distributions (QCD). [5]
Employer-sponsored qualified retirement plans, such as 401(k) plans, require the same distributions that IRAs do. The beginning date requirement may be later than the date for IRAs. Although the rules require RMDs to begin by April 1 of the year after the individual reaches age 72, [lower-alpha 1] participants in an employer-sponsored plan can usually wait until April 1 of the year after retirement (if later than age 72 [lower-alpha 1] ) to begin distributions unless the individual owns 5% or more of the employer who is sponsoring the plan.
In addition, employer-sponsored plans differ from IRAs in rules relating to aggregation. A person with multiple IRAs may add the balances in each account to determine the total RMD for the year, then take that full amount from a single IRA, or split it in any manner between two or more IRAs. However, employer-sponsored plans must remain distinct; the RMD calculation for each is performed separately, and the distributions must be taken from each plan individually. Exception: If the individual has more than one 403(b) tax-sheltered annuity account, the individual can total the RMDs and then take them from any one (or more) of the tax-sheltered annuities [6]
Distributions after death must be made to the named beneficiaries of the decedent's IRA or qualified plan. Legislation passed in 2006 allows qualified retirement plans to be amended to offer a "nonspouse rollover". If the rollover is available, a beneficiary may make a direct transfer of the funds to an inherited IRA, which must be in the name of the decedent for the benefit of the named beneficiary. This became effective beginning in 2007.
IRA beneficiaries do not require a nonspouse rollover; an IRA beneficiary can have a decedent's IRA retitled as an inherited IRA without a rollover transaction. (Spouses have much greater rollover rights and can delay distributions until they are age 72 [lower-alpha 1] if they choose.) A nonspouse IRA beneficiary must either begin distributions by the end of the year following the decedent's death (they can elect a "stretch" payout if they do this) or, if the decedent died before April 1 of the year after he/she would have been 72, [lower-alpha 1] the beneficiary can follow the "5-year rule". The suspension of the RMD requirements for 2009 also meant that when counting the 5-year rule, 2009 was disregarded.
Under the 5-year rule, the entire account balance must be withdrawn over a 5-year period. The rule does not require a certain amount each year, or an even division between the five years. However, with the 5-year distribution method, the entire remaining balance becomes a required distribution in the fifth year. If a decedent has named his/her estate or a charity as a beneficiary and the 5-year rule applies, no "stretch" payout is possible. If an estate or charity is a beneficiary of a part of the account, the same holds true unless certain remedial measures are taken by September 30 of the year after death.
The 5-year rule does not apply if the decedent died after having started his/her required minimum distributions (generally if he/she died later than April 1 after reaching age 72 [lower-alpha 1] ). In that case, there is no 5-year rule, and the beneficiary takes distributions over the length of his/her own life expectancy or the remaining life expectancy that the decedent would have had (using government tables). If the IRA owner named a non-person (such as his estate) as the beneficiary and had died after beginning required minimum distributions, then the estate or other non-person beneficiary may take distributions over the remaining life expectancy the decedent would have had.
If the decedent died before age 72 [lower-alpha 1] and the beneficiary does not start a lifetime payout by the end of the year after the death, the 5-year rule does apply. Also, if the decedent died before that date and had no beneficiary (for example if he/she named the estate as beneficiary or a charity) the 5-year rule applies. Many retirement plans also trigger the 5-year rule.
This is an overview of rules based on Internal Revenue Code Section 401(a)(9). The rules are detailed at Treas. Regs. 1.401(a)(9)-1 to -9 and 1.408-8. [7] The nonspouse rollover rules were passed in Section 829 of the Pension Protection Act of 2006 and interpreted by IRS Notice 2007-7, 2007-5 IRB 1.
In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their paychecks, and may be matched by the employer. This pre-tax option is what makes 401(k) plans attractive to employees, and many employers offer this option to their (full-time) workers. 401(k) payable is a general ledger account that contains the amount of 401(k) plan pension payments that an employer has an obligation to remit to a pension plan administrator. This account is classified as a payroll liability, since the amount owed should be paid within one year.
An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's earned income for the taxpayer's eventual benefit in old age. An individual retirement account is a type of individual retirement arrangement as described in IRS Publication 590, Individual Retirement Arrangements (IRAs). Other arrangements include employer-established benefit trusts and individual retirement annuities, by which a taxpayer purchases an annuity contract or an endowment contract from a life insurance company.
A Roth IRA is an individual retirement account (IRA) under United States law that is generally not taxed upon distribution, provided certain conditions are met. The principal difference between Roth IRAs and most other tax-advantaged retirement plans is that rather than granting a tax reduction for contributions to the retirement plan, qualified withdrawals from the Roth IRA plan are tax-free, and growth in the account is tax-free.
A 529 plan, also called a Qualified Tuition Program, is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. In 2017, K–12 public, private, and religious school tuition were included as qualified expenses for 529 plans along with post-secondary education costs after passage of the Tax Cuts and Jobs Act.
The Economic Growth and Tax Relief Reconciliation Act of 2001 was a major piece of tax legislation passed by the 107th United States Congress and signed by President George W. Bush. It is also known by its abbreviation EGTRRA, and is often referred to as one of the two "Bush tax cuts".
In the United States, a 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organizations, and self-employed ministers in the United States. It has tax treatment similar to a 401(k) plan, especially after the Economic Growth and Tax Relief Reconciliation Act of 2001. Both plans also require that distributions start at age 72 (according to the rules updated in 2020), known as Required Minimum Distributions (RMDs). Distributions are typically taxed as ordinary income.
A health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). The funds contributed to an account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year to year if they are not spent. HSAs are owned by the individual, which differentiates them from company-owned Health Reimbursement Arrangements (HRA) that are an alternate tax-deductible source of funds paired with either high-deductible health plans or standard health plans.
The Employee Retirement Income Security Act of 1974 (ERISA) is a U.S. federal tax and labor law that establishes minimum standards for pension plans in private industry. It contains rules on the federal income tax effects of transactions associated with employee benefit plans. ERISA was enacted to protect the interests of employee benefit plan participants and their beneficiaries by:
Universal life insurance is a type of cash value life insurance, sold primarily in the United States. Under the terms of the policy, the excess of premium payments above the current cost of insurance is credited to the cash value of the policy, which is credited each month with interest. The policy is debited each month by a cost of insurance (COI) charge as well as any other policy charges and fees drawn from the cash value, even if no premium payment is made that month. Interest credited to the account is determined by the insurer but has a contractual minimum rate. When an earnings rate is pegged to a financial index such as a stock, bond or other interest rate index, the policy is an "Indexed universal life" contract. Such policies offer the advantage of guaranteed level premiums throughout the insured's lifetime at a substantially lower premium cost than an equivalent whole life policy at first. The cost of insurance always increases, as is found on the cost index table. That not only allows for easy comparison of costs between carriers but also works well in irrevocable life insurance trusts (ILITs) since cash is of no consequence.
The 457 plan is a type of nonqualified, tax advantaged deferred-compensation retirement plan that is available for governmental and certain nongovernmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pretax or after-tax (Roth) basis. For the most part, the plan operates similarly to a 401(k) or 403(b) plan with which most people in the US are familiar. The key difference is that unlike with a 401(k) plan, it has no 10% penalty for withdrawal before the age of 55. These 457 plans can also allow independent contractors to participate in the plan, where 401(k) and 403(b) plans cannot.
A retirement plan is a financial arrangement designed to replace employment income upon retirement. These plans may be set up by employers, insurance companies, trade unions, the government, or other institutions. Congress has expressed a desire to encourage responsible retirement planning by granting favorable tax treatment to a wide variety of plans. Federal tax aspects of retirement plans in the United States are based on provisions of the Internal Revenue Code and the plans are regulated by the Department of Labor under the provisions of the Employee Retirement Income Security Act (ERISA).
A Savings Incentive Match Plan for Employees Individual Retirement Account, commonly known by the abbreviation "SIMPLE IRA", is a type of tax-deferred employer-provided retirement plan in the United States that allows employees to set aside money and invest it to grow for retirement. Specifically, it is a type of Individual Retirement Account (IRA) that is set up as an employer-provided plan. It is an employer sponsored plan, like better-known plans such as the 401(k) and 403(b), but offers simpler and less costly administration rules, as it is subject to ERISA and its associated regulations. Like a 401(k) plan, the SIMPLE IRA can be funded with pre-tax salary contributions, but those contributions are still subject to Social Security, Medicare, and Federal Unemployment Tax Act taxes. Contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans as compared to conventional defined contribution plans like Section 402(g), 401(k), 401(a), and 403(b) plans.
A traditional IRA is an individual retirement arrangement (IRA), established in the United States by the Employee Retirement Income Security Act of 1974 (ERISA). Normal IRAs also existed before ERISA.
The Roth 401(k) is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A, and represents a unique combination of features of the Roth IRA and a traditional 401(k) plan. Since January 1, 2006, U.S. employers have been allowed to amend their 401(k) plan document to allow employees to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions. The same change in law allowed Roth IRA type contributions to 403(b) retirement plans. The Roth retirement plan provision was enacted as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001).
Substantially equal periodic payments (SEPP) are one of the exceptions in the United States Internal Revenue Code that allows a retiree to receive payments before age 591⁄2 from a retirement plan or deferred annuity without the 10% early distribution penalty under certain circumstances.
A self-directed individual retirement account is an individual retirement account (IRA) which allows alternative investments for retirement savings. Some examples of these alternative investments are real estate, private mortgages, private company stock, oil and gas limited partnerships, precious metals, digital assets, horses and livestock, and intellectual property. The increased investment options available in self-directed IRAs prompted the SEC to issue a public notice in 2011 due an increased risk of fraud in alternative assets.
The Pension Protection Act of 2006, 120 Stat. 780, was signed into law by U.S. President George W. Bush on August 17, 2006.
Rollovers as business start-ups (ROBS) are arrangements in the United States in which current or prospective business owners use their 401(k), IRA or other retirement funds to pay for new business start-up costs, for business acquisition costs or to refinance an existing business. In 2008, the Internal Revenue Service set up the ROBS Compliance Project to monitor such arrangements.
A Solo 401(k) (also known as a Self Employed 401(k) or Individual 401(k)) is a 401(k) qualified retirement plan for Americans that was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse(s). The general 401(k) plan gives employees an incentive to save for retirement by allowing them to designate funds as 401(k) funds and thus not have to pay taxes on them until the employee reaches retirement age. In this plan, both the employee and his/her employer may make contributions to the plan. The Solo 401(k) is unique because it only covers the business owner(s) and their spouse(s), thus, not subjecting the 401(k) plan to the complex ERISA (Employee Retirement Income Security Act of 1974) rules, which sets minimum standards for employer pension plans with non-owner employees. Self-employed workers who qualify for the Solo 401(k) can receive the same tax benefits as in a general 401(k) plan, but without the employer being subject to the complexities of ERISA.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, Pub. L.Tooltip Public Law 116–94 (text)(PDF), was signed into law by President Donald Trump on December 20, 2019 as part of the Further Consolidated Appropriations Act, 2020.