This article originally appeared in the April 2016 issue of Smart Business Philadelphia magazine.
Typically, qualified retirement plans such as 401(k)s and individual retirement plans (IRA’s) make up a large portion of an individual’s assets. As such, it is extremely important to be aware of the complex rules surrounding the distribution of retirement assets. The penalties for running afoul of these rules are some of the highest imposed by the Internal Revenue Code.
Smart Business spoke with Susan P. Stutzman, CPA, and a director in the Tax Strategies group at Kreischer Miller, about some of the more common mistakes taxpayers make in the distribution of their retirement assets and how to avoid them.
Required minimum distribution (RMD) rules
When an individual reaches the age of 70½, they are required to begin taking distributions from their IRA or 401(k) by April 1 of the year following the attainment of that age.
If still working, the 401(k) may further be delayed unless the individual owns more than 5 percent of the sponsoring employer. Most IRA and 401(k) administrators track your age and notify you when you must start taking distributions, but it is the taxpayer’s responsibility to make sure the RMD is made. There is a penalty of 50 percent of an RMD not made on a timely basis.
In addition, there may be confusion about when the second RMD must be made. Although the first distribution can be delayed until April 1 of the year following attainment of age 70½, the second distribution must be made by Dec. 31 of that same year, resulting in two RMDs in the same year. If this places you in a higher tax bracket, you may want to take your distribution prior to Dec. 31 of the year you reach 70½.
Changes in RMD upon the death of owner
If the rules for RMDs are not complicated enough, they become even more so when the account owner dies. Different rules apply depending on whether the owner dies before or after he is required to commence the RMD and whether or not he designated a beneficiary.
It is extremely important that you consult with an informed advisor to guide you through these rules as the proper course of action will be highly dependent on your specific circumstances. In addition, the decedent’s executor should make certain that an RMD is not missed in the year of death, thereby avoiding a 50 percent penalty.
The designation of a beneficiary is important as it not only affects who receives the benefits, but also affects how long the funds can remain in the retirement account. Generally, the surviving spouse has the most options regarding the eventual payout of the funds and the most tax advantages. However, it is important to consider naming contingent beneficiaries. There are numerous post-mortem planning opportunities.
For example, the surviving spouse can disclaim their interest during a limited time after the account owner’s death. New beneficiaries cannot be named after the date of death, but if the spouse disclaims their interest, the account would then pass to the contingent beneficiaries.
If the spouse does not need the funds, the disclaimer technique would allow the contingent beneficiaries (perhaps the decedent’s children) to withdraw the funds over their longer life expectancy.
In addition, there may be reasons to name a beneficiary other than a spouse to benefit children from a previous marriage or to provide for someone with special needs.
The rules relating to retirement plan distributions are quite complex. In order to maximize the tax deferral and avoid penalties, it is very important to discuss your particular circumstances with a qualified professional who can successfully guide you through the rules. ●
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