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Helping Your Clients With Required Minimum Distributions

Helping Your Clients With Required Minimum Distributions

Among the many compliance requirements for a 401(k) plan is the obligation to make required minimum distributions (RMDs) to savers yearly. Although the distribution need not be made until April of the year after the saver turns age 73, advisors should check in with their clients throughout the year to make sure their service providers are prepared. Both savers and employers face stiff penalties–including plan disqualification–if distributions are missed or aren’t large enough. Advisors can also help employers now avoid those penalties by checking for and quickly correcting missed RMDs.

Some Background: What Is a RMD and How Is It Calculated?

Savers in 2024 must start withdrawing from their tax deferred retirement plans by April of the year after they turn age 73. But in 2017, when the age was 70 ½, individuals faced double pain: the IRS required them to take an RMD by April 1, 2018, and a second RMD by December 31, 2018. RMDs must then be taken by December 31 each year thereafter. These minimum distribution rules apply to tax-deferred retirement plans, including IRAs, 401(k) plans, 403(b) plans, profit sharing plans, and other defined contribution plans.

Advisors Should Help Plan Sponsor Clients Throughout the Year

The IRS assesses large penalties for missed RMDs. While the major crunch time for making RMDs has now passed, don’t let your client forget to check for any missed distributions. Ask the recordkeeper to confirm that all appropriate participating employees were identified and review the plan language to double-check. If an RMD is missed but detected and corrected quickly, you can save the plan and participating employees a big headache. Advisors should also understand the demographics of their client’s tax-deferred retirement plans and caution them to pay special attention to aging savers who turned or are nearing age 70 1/2. Advisors can also help employers locate missing employees, which the IRS also requires in order to maintain tax-qualified status.

Opportunities for Advisors to Ease the Pain and Help With Planning

The RMD is included in taxable income. Therefore, the RMD can push a saver into a higher tax bracket and become subject to additional state and local taxes as well as a 50% excise tax for missed or inadequate RMDs.

Ensuring clients plan early for RMDs is key. For example, advisors can help clients avoid having both RMDs taxed as income for the same year by encouraging them to make the first withdrawal in the year the saver turns 70 1⁄2. Advisors should also help clients evaluate whether they missed taking an RMD or received an RMD that wasn’t large enough. The saver may be taxed an additional 50% penalty on a missed or insufficient RMD. If there was a reasonable error, the advisor can help the client request a tax waiver by filing Form 5329 and preparing a good faith explanation.

Advisors can also help reduce a client’s tax burden by making a “qualified charitable contribution” that will count towards the RMD and can be excluded from taxable income. Advisors should also help savers review their benefit plan document since that might allow them to wait until the year they actually retire to take the first RMD. Individuals who own more than 5% of the business sponsoring the plan must take the distribution, regardless of whether or not they are actually retired.

For individuals with multiple tax-deferred accounts or inherited tax-deferred accounts, the advisor may be able to help the decide which accounts to take the withdrawal. For example, investors who make IRA and 401(k) contributions with after-tax money do not receive any tax deductions on their contributions. Therefore, it can be less expensive for them to make RMDs from those after-tax accounts.

Advisors should also help clients who contributed only on a pre-tax basis to examine their retirement plans carefully. For individuals with multiple IRAs, RMDs may be aggregated. In other words, the IRA owner calculates the RMD separately for each IRA account but may take a distribution from only one of them to satisfy the total RMD requirements for all of them. A client with a 401(k) (or other defined contribution plan) and a traditional IRA cannot aggregate and must take a separate RMD from each plan. Advisors can also assist clients with reinvesting their distributions and estate planning strategies by advising how to pass their distributions onto their heirs.

Education Is Key…for Everyone

Be it businesses, their employees, or your private wealth clients, it’s helpful to know your demographic and who might be affected by RMDs. But most importantly, it’s important to continue to educate yourself, and your clients, to ensure everyone is prepared for what’s in store.