Required Minimum Distributions (RMDs) — CFP Exam Guide

Required Minimum Distributions (RMDs) are mandatory withdrawals from certain retirement accounts. They are designed to ensure that retirement savings are eventually taxed. The SECURE 2.0 Act changed the age at which RMDs must begin. For those born between 1951 and 1959, RMDs now begin at age 73. For those born in 1960 or later, RMDs will begin at age 75.

RMDs apply to traditional IRAs, 401(k)s, 403(b)s, and other employer-sponsored retirement plans. Roth IRAs are generally not subject to RMDs during the owner's lifetime. The account owner is responsible for calculating and taking the RMD each year.

Failure to take the full RMD can result in a substantial penalty. Therefore, understanding the rules and calculations is crucial for both clients and CFP® professionals.

The most common method for calculating RMDs involves the Uniform Lifetime Table. This table is published by the IRS and provides a life expectancy factor based on the account owner's age as of the end of the distribution year. To calculate the RMD, divide the prior year-end account balance by the applicable life expectancy factor.

RMD = Prior Year-End Account Balance / Life Expectancy Factor

Example: Suppose a client is 73 years old and their traditional IRA balance on December 31st of the previous year was $500,000. According to the Uniform Lifetime Table, the life expectancy factor for age 73 is 27.4. Therefore, the RMD would be $500,000 / 27.4 = $18,248.18.

There's an exception to using the Uniform Lifetime Table. If the sole beneficiary of the IRA is the owner's spouse and the spouse is more than 10 years younger, the RMD can be calculated using the Joint and Last Survivor Expectancy Table. This table typically results in a smaller RMD because it considers the joint life expectancy of both spouses.

Using the Joint Life Expectancy table will result in a larger distribution period and a smaller required minimum distribution. This can be a significant benefit for clients with a large age difference between themselves and their spouse.

While subsequent RMDs must be taken by December 31st of each year, the first RMD can be delayed until April 1st of the following year. However, delaying the first RMD means taking two RMDs in the same year (the first one by April 1st and the second one by December 31st). This can potentially increase your client's tax liability.

Carefully consider the tax implications of delaying the first RMD. In many cases, it's more advantageous to take the first RMD in the year the account holder turns 73 (or 75, depending on their year of birth) to avoid bunching two RMDs into a single tax year.

The penalty for failing to take the full RMD is substantial. The penalty is 25% of the amount that should have been withdrawn but wasn't. This penalty can be avoided if the account owner can demonstrate reasonable cause for the failure and takes steps to rectify the situation.

It is crucial to track RMDs and ensure they are taken on time to avoid this costly penalty. CFP® professionals should proactively remind their clients about their RMD obligations.

The RMD rules for inherited IRAs depend on whether the beneficiary is a surviving spouse or a non-spouse. A surviving spouse has more options, including treating the inherited IRA as their own, rolling it over into their own IRA, or taking distributions as a beneficiary.

Non-spouse beneficiaries generally must take RMDs based on their own life expectancy or, if the original account owner died after their required beginning date, over the remaining life expectancy of the original account owner. The SECURE Act significantly changed the rules for non-spouse beneficiaries, particularly regarding the 10-year rule.

The SECURE Act introduced the 10-year rule for many non-spouse beneficiaries inheriting IRAs after December 31, 2019. This rule requires the inherited IRA to be fully distributed within 10 years of the original account owner's death. While annual RMDs are not required during the first nine years, the entire account balance must be withdrawn by the end of the tenth year.

There are exceptions to the 10-year rule for certain 'eligible designated beneficiaries,' such as surviving spouses, minor children (until they reach the age of majority), disabled individuals, and chronically ill individuals. These beneficiaries can generally continue to take RMDs based on their own life expectancy.

During the original owner's lifetime, Roth IRAs are not subject to RMDs. This is a significant advantage of Roth IRAs. However, after the owner's death, beneficiaries inheriting Roth IRAs are generally subject to distribution rules, including the 10-year rule for non-eligible designated beneficiaries, as outlined by the SECURE Act.

The SECURE 2.0 Act also changed the rules for Roth 401(k) and other Roth employer plans. Prior to SECURE 2.0, Roth 401(k) accounts were subject to RMD rules. SECURE 2.0 eliminated the RMD requirement for Roth 401(k) accounts, effective for distributions made after December 31, 2023.