What’s up with required minimum distributions
I get a lot of questions about retirement accounts and required minimum distributions. If the rules seem confusing to you, trust me—you are not alone. The following Q&A will hopefully clear up some of the most common misperceptions.
Q: I just inherited a Roth IRA from my uncle. My friend says I need to start taking required minimum distributions, but I thought Roth IRAs did not have RMDs. Which is correct?
A: If you establish a Roth IRA, current tax law does not require you to take minimum distributions during your lifetime. However, if you inherit a Roth from a non-spouse, you must take RMDs just like you would for any other inherited IRA. The only difference is that the distributions from the inherited Roth will not be taxable to you.
Q: If I am still working when I turn 70 1/2, can I defer my required minimum distributions until I retire?
A: The IRS requires that you begin taking minimum distributions from traditional IRAs and IRA-based plans like SEPs when you turn 70 ½ years of age. These RMDs are required whether you are working or not.
The rules are a little different for employer-sponsored plans like 401(k), 403(b) or 457(b) plans. For these plans, if you are still working and you do not own 5 percent or more of the sponsoring company, you can delay your RMD until you retire.
This difference gives rise to a tax strategy that I’ve highlighted before. If you are still working at 70 ½ and your 401k plan allows it, consider rolling your IRA into your 401k plan. This will allow you to delay taking any RMDs until you retire.
Q: I turn 70 ½ this year. I understand that the deadline to take my first RMD isn’t until April 1 of next year. Is it better to wait until next year to take my RMD or should I take it sooner?
A: The deadline to take your first RMD is April 1 of the year following the year you turn 70 ½. RMDs for subsequent years are due by December 31 of each year, so if you delay your first RMD to its April 1 deadline, you will be required to take two RMDs in one calendar year.
Depending on the amount of other income you have, taking both RMDs in one year can have tax consequences even if your IRA is fairly small. A common tax consequence for small IRAs is to make more of your social security benefits subject to taxation. For larger IRAs, taking double RMDs might cause you to pay higher premiums for Medicare Part B coverage or push you into a higher tax bracket, causing you to pay higher tax rates on capital gains. It could even subject you to the phase-out of some tax deductions. Given these potential tax effects, most people are probably better off taking their first RMD by December 31.
Q: I was told I can donate my RMD to charity. Is that true and should I do it?
A: It is true and, if you are charitably inclined, directly donating your RMD to charity is a great way to do your charitable giving. By donating your RMD directly to charity, you get the full tax deduction for your contribution, without having to recognize the RMD in your adjusted gross income. In order to be tax-free, the money needs to transfer directly from your IRA custodian to the charity. If you take the withdrawal and then donate the money, you will still get the tax deduction, but the withdrawal will be counted as part of your adjusted gross income.
It pays to be careful with your RMDs. Failure to take your RMD exposes you to one of the most onerous penalties in the tax code: 50% of the missed RMD amount. If you somehow missed your RMD deadline, all is not lost. You can request a waiver from the IRS using from 5329. If you file correctly and in a timely manner, the IRS will likely waive your penalty. Your financial advisor should be able to help you with this process.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.