Save clients from costly RMD aggregation mistakes

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When it comes to taking required minimum distributions, the source matters.

Many clients have more than one retirement plan or account. When they reach age 70½ and have to start taking RMDs from their own, non-inherited accounts, the question arises as to which of these distributions can be combined and taken from just one plan.

Advisers and clients may think it doesn't matter which account makes the distribution, as long as the total calculated amount is taken from one of the accounts. They are wrong. There are specific rules for aggregating RMDs.

IRS rules state that an RMD should be calculated for each account separately. Then, where aggregation is allowed, those RMD amounts can be added together and the distribution can be taken in any proportion from one or more of the aggregated accounts.
It’s also important to remember that an RMD cannot be rolled over from any one account to another account, and the RMD is considered to be the first funds distributed from any retirement account during the year.

Thus, an IRA CD that comes due in March cannot be moved in its entirety as a 60-day rollover to another retirement account. The RMD amount must be subtracted from the amount that is subsequently rolled over.

The same is true when a distribution is made from an employer plan. All plan distributions are considered rollovers, even when they go directly from the plan to another retirement account.

It’s crucial for advisers to understand which RMDs can be combined and which accounts must distribute their own RMDs.

IRA RMDs can, however, be transferred from one account to another. A transfer is when the IRA funds go directly from one financial institution to another. The RMD can then be taken later in the year.

Advisers must make sure the RMD is taken by clients. The new IRA custodian will not have any records of the RMD calculation, and will not have any automatic reminders for notifying anyone about the RMD in the year of the transfer.

RMDs for one type of account can never be taken from a different type of account. For example, a 401(k) RMD cannot be taken from an IRA, and an IRA RMD cannot be taken from a 403(b). This is a very common mistake and must always be avoided.

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One of the benefits of IRAs is that RMDs for multiple IRA accounts can be aggregated. This includes SEP and SIMPLE IRA accounts. The RMD should be calculated for each account separately, but after that, the RMD amounts can then be added together and taken from any one or combination of accounts.

A similar aggregation rule exists for 403(b) accounts. A client with more than one 403(b) account can calculate the RMD for each account and then add the RMDs together. The total can then be taken from one or a combination of 403(b) accounts.

When RMD mistakes are made by an adviser, the client pays the penalty.

RMDs from employer plans, not including 403(b) plans and SEP and SIMPLE IRAs, cannot be aggregated. A client with multiple 401(k), governmental 457(b) or other employer plans must calculate the RMD for each individual plan and take that RMD from that plan only.

There is no need to worry about whether or not Roth IRA RMDs can be consolidated, because Roth IRAs have no RMDs during the account owner’s life time. It can’t get much simpler than that.

Any plan making a series of substantially equal payments over a period of 10 years or more, or over life expectancy, cannot aggregate that payment with the RMDs from any other retirement account. The distribution from the account making these substantially equal payments is considered the RMD from that account only.

Your client is approaching age 70½. He comes into your office to discuss his upcoming RMDs. Just as you asked him to, he brings in a list of all his retirement accounts. He has two old 401(k) accounts, an old Keogh account, three 403(b) accounts, four IRA accounts, a SEP IRA and two Roth IRA accounts. His plan is to add together all his RMD amounts and systematically take those distributions from his smallest accounts first.

Sounds like a great plan, right? Well, let’s take a look.

First things first – when you’re trying to figure out how many accounts a client needs to take an RMD from, you must first know how many different accounts you’re dealing with. In this case, we have 13 accounts.

Next, determine what type of accounts they are and how many there are of each type, keeping owned and inherited accounts separate. Make sure you have this information correct, because getting it wrong and missing a required distribution could subject your client to a 50% penalty for any missed RMDs.

Once you’ve got your information in order, you can start anywhere.

First of all, the client has two old 401(k) accounts. The RMD for each employer’s account must be calculated. Then he must take at least the total RMD amount for each 401(k) plan from that employer’s plan. He has two RMD distributions he must take, one from each 401(k) plan. These 401(k) RMDs cannot be combined with each other or with any other RMD distribution that he must take for the year.

There is one old Keogh account. The RMD for the Keogh account must be calculated and taken from there. It cannot be combined with any other RMD distribution for the year.

Next, the client has three 403(b) accounts. He must still calculate the RMD for each of the 403(b) accounts. But he can then add these together and take his total 403(b) RMD from any one or combination of the 403(b) accounts. The 403(b) RMDs must be taken from a 403(b) account.

He also has four IRA accounts at four different IRA custodians. He has a letter from each of them detailing what the RMD should be for each account. You should double check their computations. Your client can add these four RMDs together and take the total IRA RMD from any one or a combination of IRA accounts.

In addition to the four IRAs, the client has a SEP IRA. While a SEP IRA is considered an employer plan, it is also considered an IRA for RMD purposes. The client can calculate the SEP RMD and add it to the RMD amounts for his IRA accounts. The SEP IRA RMD can be taken from either the SEP account or any of the client’s other IRA accounts, but it cannot be taken from any other type of retirement account.

Why it’s crucial for advisers to educate clients on RMD aggregation rules.

Finally, the client has two Roth IRA accounts. He can forget about these accounts – at least as far as RMDs go. Roth IRAs have no RMDs during the account owner’s lifetime.

Remember how the client wanted to take only one RMD distribution? If we look back over what we have explained to him, we find that he must take at least five different RMD distributions.

There are two potential penalties when clients make RMD aggregation mistakes: the penalty for excess contributions and the penalty for missed RMDs.

RMDs that are rolled over to another retirement plan create an excess contribution in the receiving account, which must be corrected as soon as possible.

When an excess contribution is corrected by Oct. 15 of the year after the year for which the contribution was made, the amount of the excess, plus/minus gains/losses attributable to the amount of the excess contribution must be removed from the account as well.

Simply taking a distribution from the receiving account in the amount of the RMD later in the year does not correct this problem. The IRA custodian must be informed that the distribution is a return of an excess contribution. The coding on the 1099-R for the distribution will reflect that it is a return of an excess contribution. There will be no 6% penalty when the excess is corrected in a timely manner.

It’s critical for advisers to understand which RMDs can be combined and which accounts must distribute their own RMDs, and to communicate this to their clients.

Excess contributions that are not corrected are subject to a penalty of 6% per year for every year they remain in the account. Form 5329 should be filed with the IRA owner’s tax return to report the excess contribution and to calculate the 6% penalty. This form is considered a separate tax return, so it can be filed as a stand-alone return.

When the form is not filed, the statute of limitations does not start to run for the excess contribution. If the IRS discovers the problem at any later date, they can assess the penalty, plus interest, assess failure to file penalties, plus interest, and, if the amount is large enough, assess accuracy-related penalties, plus interest.

When a distribution is taken from the wrong type of account, you have a missed RMD. For example, suppose a client accidently takes their 403(b) RMD from their IRA. This is against the rules. The client has a missed RMD in the 403(b). The penalty for a missed RMD is a steep one – it is 50% of the amount not taken.

Here’s the good news. The client can generally rectify this issue. First, they should immediately take the missed 403(b) RMD. Then, they should file Form 5329 to report the missed RMD and follow the instructions to request relief. Assuming the client can show reasonable cause for the mistake, there's a good chance the IRS will waive the 50% penalty.

It’s critical for advisers to understand which RMDs can be combined and which accounts must distribute their own RMDs, and to communicate this to their clients. There are too many mistakes made in this area, and incorrect advice often comes from the plan or custodian.

When RMD mistakes are made, however, it’s the client who pays the penalty.

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