Your RMD Must Come Out of Employer Plan BEFORE Moving Funds to an IRA

Friday, December 05, 2014

By Beverly DeVeny, IRA Technical Expert
Followe Me on Twitter: @BevIRAEdSlott

Many employer plans are making this mistake.

You have a required minimum distribution (RMD) that you must take this year on your employer plan account. You have moved those assets to an IRA without taking that RMD. The plan administrator should not have let you do that. The RMD from the plan should have come out before you moved the remaining plan balance. So, you can just take it out of the IRA to fix this, right? WRONG!!

Here’s the long version of why you cannot do that.

Under the tax code, all distributions from employer plans that are moved to another retirement account are rollovers. They can be direct rollovers where the plan assets go directly from the plan to an IRA. Or, they can be indirect rollovers where the plan distributes the assets payable to you. But, they are always rollovers.

RMDs are not eligible for rollover. An RMD amount cannot be rolled out of a plan and go to an IRA.

The first funds out of the plan are the RMD.

So, when the plan sends the entire plan balance to you or to an IRA account without sending you a check for the RMD, what you end up with is an excess contribution in the IRA. You can’t fix this by just taking out the RMD amount.

You must tell your IRA custodian that you are removing an excess contribution. In order to remove an excess contribution, you must also remove the earnings attributable to the excess contribution. Either you or your IRA custodian must do a net income calculation. Then you take a distribution for the net amount – the excess contribution (the RMD amount) +/- earnings/losses. The 1099-R will be coded to show the removal of the excess contribution.

So, you see, the issue is not as simple as it seems. If the proper procedures are not followed to correct the mistake, you continue to have an excess contribution in the IRA. Excess contributions are subject to a penalty of 6% for every year they remain in the IRA. You have until October 15 of the year after the excess contribution is made to correct it without having to pay the penalty. If you miss that deadline, you must file IRS Form 5329 with your tax return to report and pay the penalty.

 

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