Year-end Planning: Required Minimum Distributions
Required minimum distributions from tax-deferred retirement accounts must be made by December 31, with one exception.
Unlike some types of retirement account contributions, which can be made after December 31 and still count for the prior year, required minimum distributions from tax-deferred accounts (often referred to as RMDs or MRDs) must be made by December 31 to count as current year distributions. The only exception to this rule is the first year RMD from tax-deferred retirement accounts. In that case, you have until April 1 of the year after you turn 70 1/2 to take the RMD. However, you will also have to withdraw your second year RMD in the same calendar year. (Note that inherited (also referred to as “beneficiary”) tax-deferred retirement accounts have a different set of rules regarding RMDs, although the December 31 deadline still applies. To learn more, visit this IRS link.)
Below are a few tips to keep in mind as you plan your RMDs (or help a family member plan for his or her RMDs).
TIP #1 – RMDs can be aggregated (in some cases)
While the total amount of the RMD is calculated based on all of your tax-deferred retirement accounts, there is some flexibility in how the withdrawals are taken. For example, the total RMD can be taken from just one account, or in equal or unequal amounts from all of the accounts. However, the ability to aggregate the distributions applies to like accounts only. Below is an example to show how this might work.
Assume you have 3 traditional IRA accounts, 1 inherited IRA from a parent, 2 403(b) accounts, and 1 401(k) account:
- The RMDs related to the 3 IRA accounts can be withdrawn from any or all of the IRAs;
- The RMD from the inherited IRA can only be withdrawn from the inherited IRA;
- The RMDs for the 2 403(b) accounts can be withdrawn from 1 or both of the 403(b)s; and
- The RMD for the 401(k) account can only be withdrawn from the 401(k).
TIP #2 – RMDs don’t have to be taken in cash
Most people withdraw cash from their retirement accounts, but that doesn’t have to be the case. Securities equal to the value of the RMD amount can be transferred “in kind” to a non-retirement account. The cost basis of the transferred securities is the value on the date of the transfer. And, keep in mind that the holding period for the transferred securities begins as of the date of the transfer; it does not revert back to the date the securities were originally purchased in the IRA.
TIP #3 – Qualified Charitable Deduction option
If you are charitably inclined and over 70 1/2, you might consider a Qualified Charitable Deduction (QCD) in lieu of depositing the RMD amount to your non-retirement account and then making a donation.
With a QCD, you can transfer up to $100,000 directly from your IRA to one or more qualified charities in any given year. If the amount transferred is equal to or greater than your RMD amount, the RMD is satisfied. Why bother with this? Unlike regular withdrawals from your tax-deferred retirement accounts, QCDs are not reported as income on your income tax return. Keeping your taxable income lower may increase your opportunity to take certain tax credits and deductions, reduce the tax on Social Security income, and reduce Medicare premiums.
A few additional items to keep in mind:
- The QCD must go directly to the charity; it cannot first be deposited to your non-retirement account.
- QCDs cannot currently be directed to a donor-advised fund.
- The transfer must take place by December 31.
TIP #4 – Potential IRS relief if you forget an RMD
Despite all of the information and reminders, it is not uncommon, especially for younger people with inherited IRAs, to forget to take their RMDs. Unfortunately, forgetting can be expensive as the IRS can impose a 50% excise tax (aka penalty) on the amount that should have been withdrawn.
Because missed RMDs are a relatively common occurrence, the IRS has a process in place to deal with this. If you neglect to take your RMD, you will need to complete Section 9 of IRS Form 5329 (use the form for the specific year of the missed RMD) and hope for the best. According to the Form 5329 instructions, the IRS “can waive part or all of this tax if you can show that any shortfall in the amount of distributions was due to reasonable error and you are taking reasonable steps to remedy the shortfall. If you believe you qualify for this relief, attach a statement of explanation and file Form 5329” as directed.
December is a busy month! If you have not already taken your RMDs, don’t delay any longer. Not sure how much to take or don’t remember if it has been processed? Check your account statement as many firms print the RMD amount on the statement and indicate if the amount has been withdrawn. Or, call the financial institution. Alternatively, to determine the RMD amount, use one of the free calculators available at Schwab, Fidelity, and many other financial institutions.
Finally, if you know you are someone who is likely to forget to take your RMDs, talk to your financial institution(s) about establishing automatic RMDs as soon as possible. That 50% excise tax imposed by the IRS for late RMDs is not how you want to spend your hard-earned retirement savings!