Time for your annual IRA checkup

Time for your annual IRA checkup

October 04, 2022

According to the Internal Revenue Service, more than 60 million Americans have individual retirement accounts with an estimated value exceeding $11 trillion. If you are an IRA owner, here are four things to do each year to make sure your IRA is in good shape.

  1. Review your IRA beneficiary designations. This is especially important if you have experienced a significant life event like a marriage, divorce, or death of a spouse. These events can be overwhelming and it is common for people to completely forget to update their IRA beneficiaries. An annual review will help make sure your beneficiary designations are in proper order.
  2. Take full advantage of IRA funding opportunities. IRAs and other retirement accounts provide excellent tax incentives to save for retirement. However, you are limited in how much money you can add to your IRA each year. If you want to maximize the value of your IRA, you need to make sure you maximize your annual contribution.
  3. Compute your RMD and make sure you take it before year-end. Once you turn 72 years old, you are required to take a minimum distribution from your retirement accounts every year. Your RMD for a particular year is calculated based on the value of your IRA at the end of the prior year and your IRS distribution period which is determined by your age at the end of the current year. Your advisor or brokerage firm can help you calculate the amount of your RMD.

Distributions from IRAs are pretty flexible. If you have multiple IRAs, you can take the RMD for one IRA out of a different IRA or you can aggregate them all together and take the entire distribution from a single IRA. The RMD deadline is December 31. If you fail to withdraw the full amount of your RMD by that deadline, you will be subject to a penalty equal to 50 percent of the undistributed amount.

Sometimes people miss the RMD deadline for reasons outside of their control. If you are in that situation, you can request a waiver of the penalty by filing IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts. If you can make the case that the shortfall was due to a reasonable error and that you are taking steps to remedy the shortfall, you have a very good chance of escaping the penalty. Remedying the shortfall includes taking the withdrawals and paying the associated taxes.

  1. Give yourself ample time to deal with special RMD situations. Withdrawing your RMD is easy if your IRA is invested in liquid financial assets like mutual funds or stocks and bonds. However, if you have a self-directed IRA invested in real estate or other illiquid assets, you may face special challenges. These special situations can take time to resolve.

For example, consider the situation caused by a self-directed IRA invested in rental property. The rental property may have significant value which would mean a large RMD. If the IRA does not have enough cash to cover the RMD, how would you fund the distribution? Fortunately, you have a couple of options.

The first option is to take the RMD from another IRA with more liquid assets. A second option is to partially distribute the property to yourself from the self-directed IRA. This distribution can be accomplished by drafting a new quit claim deed for the property showing updated ownership percentages split between you and your IRA. You would send the updated deed to the self-directed IRA custodian for their approval and signature. Once approved, you would file the deed with the county recorder’s office. The custodian will report the distribution to the IRS using Form 1099R. Although the process is simple, it takes time, so make sure you get started early enough to get it done before the RMD deadline.

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes your questions about investments, taxes, retirement, or estate planning.  You can contact Steve by calling 831-372-3426 or emailing him at smerrell@montereypw.com.