When most people start drafting estate plans, they think in simple terms. This account goes to that person, or that much money is donated to this organization. However, when you start digging into the process, you’ll quickly realize that actual estate plans are much more complex than that. For example, a good plan should account for the required minimum distributions from any retirement accounts you may have.
But what is a required minimum distribution? That’s an excellent question. Below, we break down what these distributions are, when they’re necessary, and how to ensure they are fully accounted for in your plan.
What Are Required Minimum Distributions?
A required minimum distribution (RMD) is the minimum amount the IRS requires you to withdraw from a retirement account once you reach a designated age. Currently, that age is 72, but it has changed in the past. Once you reach your 72nd birthday, you are legally required to start withdrawing funds from these accounts. The specific amount is determined based on the size of the account and the owner’s age.
RMDs are intended to exhaust accounts over time. This is a design feature, not a flaw. Funds within retirement accounts receive significant tax protections because they are designed to support the account owner once they stop working. In exchange for these benefits, the IRS enforces RMDs to ensure the accounts cannot continue accruing interest forever.
Ideally, your retirement account will be large enough that RMDs will still not exhaust the funds while you are alive. However, this means your account and its RMDs will become part of your overall estate. You’ll need to decide how to handle this in your estate plan, or it may cause unnecessary legal and tax complications for your beneficiaries.
What Accounts Have RMDs?
RMDs are tied to certain accounts intended to fund owners’ retirements. The specific accounts that require minimum distributions include:
- Most 401(k) and 403(b) plans: These are employers offering retirement benefits to qualified employees. The employee can deposit a limited amount of pre-tax income, and employers can match those contributions for tax benefits.
- Traditional and rollover IRAs: These accounts are often used by individuals who are not eligible for a 401(k) or 403(b). They allow the owner to deposit a set amount of pre-tax, tax-deductible dollars annually.
- SIMPLE and SEP IRAs: These are crossover IRAs used by small businesses to provide employees some of the benefits of 401(k) plans. They also use pre-tax income and offer tax deductions.
- Most small-business accounts: For example, self-employed 401(k) plans are usually included because they rely on tax-deductible contributions.
- Profit sharing and money purchase plans: These retirement plans rely entirely upon employer contributions that can vary yearly and grant the business tax benefits, so RMDs are required.
It is important to note that RMDs do not apply to Roth IRAs and 401(k)s held by the original owners because these contributions are made in after-tax dollars. However, if you pass on any retirement account to your beneficiaries, they must begin taking RMDs immediately, regardless of whether the account is a Roth.
What are examples of required minimum distributions?
Say you have a traditional IRA with a balance of $100,000. You are typically required to take an RMD from this account the year you turn 72. Using the Uniform Lifetime Table found in IRS Publication 590, you find that your distribution period is 27.4 this year. You would divide the total value of your IRA balance by your distribution period to find the RMD for the year. In this case, you must withdraw $3,649.64 from the account.
The basic method for finding RMDs is the same regardless of the plan. You may need to use a different table from Publication 590, depending on your circumstances. For example, if your spouse is more than 10 years younger than you and is the sole beneficiary of your IRA, you would use Table II and find the distribution period based on your respective ages.
The Impact of RMDs on Estate Plans
You need to account for RMDs in your estate plan for two reasons. First, the funds you withdraw from your accounts need to go somewhere. Whether you convert them into liquid funds, invest them, or use them to support yourself, they will affect your overall estate. You should decide how you want to use them so you can predict how they will alter your finances and plan accordingly.
Second, if your retirement account still has funds when you pass, it will be inherited by your beneficiaries. Regardless of age, they will immediately be required to take RMDs from the account. They will also be permitted to withdraw the funds and close the account.
Depending on your goals for your estate, this may or may not align with your preferences. For example, you may have a young child and would like the funds released to them when they are 21. Or perhaps you have made wise investments and want ownership of those stocks to remain in your family. In cases like these, you can create a trust and name it as the account’s sole beneficiary. While the trust will still be required to take RMDs, you can set the terms for their use.
Accounting for RMDs in Your Plan
RMDs may be beneficial while you are retired, but they can make estate planning more complex. If you have retirement accounts subject to RMDs, you should ensure your plan accounts for them now and in the future. The best way to get started is by talking to an experienced estate planning attorney. At the Law Offices of Denise Eaton May, P.C., we are dedicated to helping our clients develop plans that account for complex matters like these. Learn more about how we can help you draft a plan for RMDs by scheduling your consultation today.