Guide to Required Minimum Distributions (RMD) for NRIs

If you have worked in the US for several years, contributed to US retirement accounts, and have since moved back to India, your US retirement account doesn't disappear. Instead, the IRS requires you to start withdrawals at some point. These mandatory withdrawals are known as required minimum distributions or RMDs.

RMD is the minimum amount that you need to withdraw from your tax-deferred retirement account every year after you reach a certain age. It is a mandatory requirement, and you cannot overlook it as it can lead to severe penalties. Every retirement account funded with tax-deductible contributions is subject to RMDs, except Roth IRAs.

Moreover, you will be subject to US RMD rules regardless of where you live. RMD withdrawal amount is calculated by dividing your account balance as of December 31 of the prior year by a life expectancy factor. Also, RMDs for NRIs who manage finances across two countries may have additional layers that most standard retirement guides may not cover.

In this guide, we will cover everything you need to know about RMDs - meaning, when they start, how they are taxed, and mistakes to avoid.

What is a Required Minimum Distribution (RMD)?

A required minimum distribution for an NRI is the minimum amount that the IRS requires you to withdraw from your tax-deferred retirement account each year. This rule applies after you reach a certain age.

You must be thinking why, so the logic is very clear behind this. When you contribute to a traditional IRA or 401(k), you receive a tax deduction at that time. The IRS only postpones taxation on such funds, but they do not eliminate it, and RMDs are basically the method through which the government eventually collects this deferred tax. Hence, you must mandatorily withdraw a minimum amount each year and pay ordinary income tax on it to ensure the IRS receives its portion.

In short, RMDs are mandatory withdrawals from US retirement accounts that must be taken every year. Also, it is taxed as ordinary income in the year you withdraw it.

Keep in mind that RMDs do not apply to Roth IRAs during the lifetime of the original owner. It is because contributions to Roth accounts are made with after-tax dollars*. So, it avoids the mandatory withdrawal requirement from the IRS.

Now that we know that Roth IRAs don't require RMDs, we will discuss the accounts that require an RMD.

Which Retirement Accounts Requires an RMD?

Any retirement account that is funded with tax-deductible contributions is generally subject to RMDs, except Roth IRAs. Here is a detailed breakdown of the retirement accounts that require an RMD and accounts that don't require an RMD:

Accounts That Require an RMD

• Rollover IRA
• SIMPLE IRA
• Traditional IRA
• Profit-sharing plans
• SEP IRA (Simplified Employee Pension)
• 401(k) — traditional, employer-funded
• 403(b) — typically for educators and non-profit staff
• 457(b) — government employee retirement plans
• Other defined contribution plans

Accounts That Do Not Require RMD

• Roth IRA: It doesn't require RMD during the original owner's lifetime
• Roth 401(k): Starting from 2024, Roth 401(k)s no longer require RMDs during the owner's lifetime, following the change in the SECURE 2.0 Act.

When Do RMDs Start?

The starting age for RMDs has undergone two major changes in recent years. So, NRIs who last managed their US accounts a few years ago may be working with outdated information. Consider the table below to learn about the current RMD starting ages after the SECURE 2.0 Act:

According to the SECURE 2.0 Act, signed into law in December 2022, the starting age has been adjusted to 73 for those born between 1951 and 1959. Additionally, to 75 for those born in 1960 or later. This is a significant shift in US retirement regulations that directly impacts NRIs who moved to India and need to start taking their US retirement distributions.

Moreover, you may delay your very first RMD withdrawal until 1st April of the following year. However, it means that you will have to take two RMDs in the second year, one RMD for the initial year and another for the subsequent year. This will end up increasing your taxable income significantly for that year and put you into a higher tax bracket. Hence, it is advised to take your first RMD in the due year itself until there's a very strong reason to postpone it. 

Moving further, we will discuss what IRC Section 401(a)(9) is. 

Understanding IRC Section 401(a)(9)

IRC Section 401(a)(9) is the provision in the IRS (Internal Revenue Service) that governs the regulations of RMD. This includes starting ages, calculation methods, and distribution categories for qualified retirement plans. 

According to Section 401(a)(9), the RMD amount is determined by dividing your account balance as of December 31 of the prior year by a life expectancy factor. You can find the life expectancy factor from the IRS uniform lifetime table or the joint and last survivor table. 

The IRS updates these tables periodically. So, with the latest updates in 2022, it reflects longer life expectancies and lower RMD amounts than previously calculated. It means that more funds will remain in your account to grow before you are obliged to withdraw them.

Now, you must be thinking that if you relocate to India, your RMD responsibility will be nullified. This is one common misconception that many NRIs have. Let's clear this. 

RMD Rules for NRIs After Moving to India

Moving to India doesn't avoid the obligations you have for your US retirement account. Instead, it adds an extra cross-border element that requires careful planning. Here are some of the common rules regarding RMD for NRIs who relocate to India:

You Remain Subject to US RMD Rules Regardless of Where You Reside

Regardless of your resident status or the place you reside, you will still be subject to comply with US RMD regulations. The IRS mandates everyone who holds a US retirement account and has reached the RMD starting age to make the required withdrawal each year. If they fail to do it, they will incur a penalty. 

RMDs Will Still Be Taxed in the US

Distributions from traditional IRAs and 401(k) are subject to US withholding tax when it is paid to a non-resident alien (NRA). However, the typical withholding rate on pension and annual income paid to Indian residents can be decreased under the India-US tax treaty. The applicable U.S. withholding rate depends on the relevant provisions of the India-US DTAA, the nature of the retirement distribution, and whether valid treaty documentation such as Form W-8BEN has been submitted. 

To claim the benefits of the treaty and avoid the default 30% withholding rate, you must submit Form W-BEN to your custodian or plan administrator.

RMDs are Taxable in India As Well

Once you become an Indian tax resident, mainly once you reach the ROR (Resident and Ordinarily Resident) status, your worldwide income becomes taxable in India. It also includes US retirement distributions.

But don't worry, you get the option to claim a credit for US taxes withheld by claiming the benefits of the India-US Double Taxation Avoidance Agreement (DTAA). It means you will not be taxed on the same income twice. However, remember that you may still be liable to pay the difference. It applies if the tax rate in India on that income is higher than the amount withheld in the US. 

FBAR and Form 8938 Still Apply

If your US retirement accounts exceed the applicable thresholds, you may still have to file FBAR (FinCRN Form 114) and Form 8938. This obligation depends on your US tax filing status and account balances.

You should consult a US CPA to confirm whether these requirements apply to you after you move to India. Next, we will learn about RMD taxation rules for NRIs in India and the US.

Taxation of RMDs for NRIs in India and the US

To ensure proper planning for retirement income, you need to understand how RMDs are taxed on both sides:

Taxation of RMDs in the US

Distributions from traditional IRAs and 401(k) are taxed as ordinary income in the US. For NRIs who are classified as non-resident aliens for US tax purposes:

• The default withholding rate is 30% of the gross distribution.
• You can reduce this figure by submitting a valid Form W-8BEN and claiming the benefits of the India-US treaty. The applicable rate will depend on the income classification under the treaty.
• To report US-sourced income, claim the right withholding credits, and potentially recover any over-withheld amounts as a refund, you must file Form 1040-NR. 

Taxation of RMDs in India

Once you become an Indian tax resident:

• RMD is generally categorised as foreign pension or foreign income, and it will be taxed at your applicable Indian income tax slab rate.
• You can claim a foreign tax credit under the India-US DTAA (Article 25) for taxes withheld or paid in the US.
• This credit offsets your Indian tax on the same income. It means that you will only have to pay the higher of the two countries and not both in full. 

Practical Tax Planning Consideration: NRIs returning to India can benefit from RNOR (Resident but not Ordinarily Resident) status for 2-3 years after their return. It allows foreign pension income, including retirement distributions from the U.S., to be non-taxable in India during this period. This creates an opportunity where only US tax applies to required minimum distributions (RMDs). Those who can structure large distributions to fall within the RNOR window may experience a lower overall tax burden. 

Let's consider an example to illustrate this.

Common RMD Mistakes NRIs Make

Here are some of the common mistakes that NRIs make with required minimum distributions (RMDs):

Not Aware of the RMD Starting Age

Many NRIs who left the US before the SECURE 2.0 Act was enacted in 2022 may still think that the starting age for RMDs is 70½ or 72. 

However, the new ages are 73 or 75 based on the year of birth. It means that some NRIs might not need to start withdrawals as early as they think. Similarly, some NRIs may have unintentionally missed their start date. 

Failing to Submit Form W-8BEN

Not having a valid W-8BEN on file leads to custodians withholding at the default rate of 30%. For NRIs living in India who are eligible for a treaty rate reduction, this results in considerable over-withholding that must be reclaimed through a US tax return instead of being retained in the account. 

Assuming RMDs Don't Apply Because They Live in India

NRIs are not exempt from RMDs based on their location of residence. So, if an individual has a US tax-deferred retirement account and has reached the starting age, the RMD obligation still stands, regardless of residency. 

Missing the Deadline

Generally, RMD must be withdrawn by the 31st of December each year. The only exception is the first RMD year, which allows withdrawal until April 1 of the following year. However, taking two RMDs in one year will have its tax consequences. Similarly, missing the December 31 deadline in any subsequent years will incur a penalty. 

Penalty for Missing RMD

The excise tax for failing to take the required minimum distribution is 25% of the amount due. This may be reduced to 10% if corrected within a two-year window per SECURE 2.0. Remember that this is in addition to any income tax on that distribution.

The Bottom Line

Required minimum distributions are a mandatory aspect of holding US retirement accounts, and relocating to India does not exempt one from this requirement. However, what changes is the tax picture because it involves two countries, different filing responsibilities, a treaty credit system, and a window of RNOR status which can be used strategically. 

The key priorities are clear: your RMD starting age depends on current regulations, submit Form W-8BEN to your plan custodian to secure the proper treaty withholding rate, ensure RMDs are taken by 31 December each year, and also coordinate US and Indian tax filings effectively. This will ensure that the foreign tax credit can be claimed accurately.

Moreover, NRIs who have significant US retirement accounts, especially those near the RMD starting age or recently moved to India, must connect with an expert at Savetaxs. At Savetaxs, we have a team of CAs and CPAs who are expert with cross-border taxation, finance, and other rules. Our team can help you stay compliant and file your taxes accurately by ensuring you stay compliant with the legal requirements. Connect with us right away, as we are working 24/7 across all time zones.