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When is a RMD a RMD?

Minima Cackling Goose

Minima Cackling Goose (Photo credit: K Schneider)

I receive quite a few questions from folks looking for clarification on the rules around Required Minimum Distributions upon reaching age 70½, so I thought I’d jot down a couple of facts about them that you may find interesting.

When can I take the distribution?

Looking through some notes from readers I found one where it was asked (this is paraphrased for clarity):

My birthdate is April 10, 1943, so I will reach age 70½ on October 10, 2013.  Do I need to wait until October 10 or after to take a distribution so that it is counted as my RMD?

I responded to this question by saying that, to be safe, I suggest the reader wait until after October 10 to take the distribution.

However. (there’s always a however in life, isn’t there?)

I subsequently received a message from a reader (thanks, TAM!) with the following updated information:

It is, in practice, fully believed that the IRS looks at the YEAR you turn 70 1/2 and NOT the birthdate.  When reviewing IRS.gov they are very concerned about making sure one gets the RMD by the last date possible and do not really address how soon a person can take it.  Such is government! But in practice, if your birthday makes the date you turn 70 1/2 turn out to be 12/31 or 12/30 we generally advise the client to take the RMD during that year to avoid having to take two RMD’s the next year.

I thought TAM’s information might be helpful to folks who are facing this decision.  It still won’t hurt to wait, but according to TAM, you could take the distribution any time during that year when you reach age 70½.

How does IRS know I’ve taken the distribution?

This question comes up pretty often as well:

Do I need to send in a form or something to let the IRS know that I’ve taken my required minimum distribution?

When you’re subject to RMD during a particular year (including the year you reach age 70½), the first money that you withdraw from your IRA(s) is considered to be your RMD.  As long as you take at least enough distribution from the account to satisfy the RMD requirement, you’re golden.

Your IRA custodian sends a copy of your 1099-R form to the IRS, as well as filing a Form 5498 (to indicate contributions) – so the IRS is well aware that you’ve taken the distribution.  They’re also well aware if you do not take distributions, and will be in contact with you to rectify the situation – in the form of a bill for the penalties and taxes.  Don’t rely on this as your notification!

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Take Your RMDs From Your Smallest IRA

small toad

Here’s a strategy that you could use to simplify your life: when you’re subject to Required Minimum Distributions (RMDs) after age 70½, you have the option of taking separate RMDs from each IRA that you own OR you could take all of your RMDs from one account if you like.

As long as you calculate your RMD based upon all of the IRAs that you own, you are free to take the full amount of all of your RMDs from one single account (or several accounts) if you wish.  And keep in mind that the “I” in IRA stands for Individual – so you can’t aggregate your IRAs with your husband’s, for example.

By doing so, you could eliminate the smaller account(s) if you wish, thereby reducing paperwork (fewer accounts and statements).  As well, you don’t have to keep track of as many accounts for estate planning. But then again, you might have chosen to have multiple accounts in order to leave certain amounts to separate groups at your passing.  If that’s the case, you can choose to take your RMDs from each individual account, reducing each account by a small amount each year.

Keep in mind that this only applies to IRAs.  If you have 401(k) plans or other non-IRA retirement accounts that also have RMD requirements, those amounts must be specifically taken from those accounts.  This can be another reason why rollover from the qualified retirement plan into an IRA can be beneficial.  You can also eliminate the smaller IRAs by rollover as well.

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Guidance on Qualified Charitable Contributions From Your IRA For 2012

United States Congress

January 1, 2013 update: Passage of the American Taxpayer Relief Act of 2012 has extended the QCD through the end of 2013.  See this article for more details.

In past tax years (through the end of 2011) there was a provision available that allowed taxpayers who were at least age 70½ years of age to make distributions from their IRAs directly to a qualified charity, bypassing the need to include the distribution as income.  The law allowed the taxpayer to use a distribution of this nature to satisfy Required Minimum Distributions (RMDs) where applicable.

This law expired at the end of 2011, but in years past Congress has acted very late in the year and retroactively reinstated this provision.  For more detail on how this provision (if not reinstated) can impact your taxes, see the article Charitable Contributions From Your IRA – 2012 and Beyond.

Guidance For 2012

If you are one of the folks who would really like to utilize the Qualified Charitable Contribution (QCD) provision for 2012, especially if you are hoping to use the distribution to satisfy your RMD for the year, read on.  In the event that Congress should happen to act on this to extend the provision late in the year, you’ll want to delay your RMD as late as possible.  This means that you shouldn’t take any other distributions from your IRAs earlier in the year.

If you’re hoping to use the QCD but you don’t want to use it to satisfy your RMD for the year, you can take as many distributions as you like, but you’ll want to wait until late in the year (probably mid-December) before you make the planned charitable contribution.

The last time that Congress extended this provision, they did it on December 10th.  As long as you make your distribution by December 31, it will still count toward the current tax year, so if you’re hoping to use QCD you can delay to that date if necessary.  Practically speaking, if Congress hasn’t acted by Christmas Eve, a change won’t likely occur after that.

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IRS Cracking Down on IRA Rules

1858

It seems that some of the rules the IRS has put in place with regard to IRAs have not always been watched very closely – and the IRS is stepping up efforts to resolve some of this.  According to the article in the WSJ, IRA Rules Get Trickier, an estimated $286 million in penalties and fees were uncollected for 2006 and 2007 tax years’ missed distributions, over-contributions, and the like.

The title of the article is a bit misleading, because the rules are not changing or getting “trickier”, the IRS is just going to be paying closer attention to what you’re doing with your account.  This is set to begin by the end of this year, after the IRS delivers their report to the Treasury on how to go about enforcing the rules more closely.

The first rule being monitored more closely is the contribution rule – for 2012, you’re allowed to contribute the lesser of $5,000 or your earned income, plus an additional $1,000 if you’re over age 50.  If you contribute more than the limit for the tax year, you will be subject to an over-contribution excise tax of 6% for each year that you leave the over-contribution in the account.  Over-contribution can also occur if your income is above the annual limits for your particular IRA.

One way to resolve over-contribution is to simply remove the excess funds from the account.  You need to make sure that you also remove any growth or income attributed to the over-contribution as well.  Another way to resolve this is to attribute the over-contribution to the following year’s contribution.  You would still owe the 6% excise tax for the prior year, but using either of these methods would get you back in shape.

Another rule is the minimum distributions rule.  If you are over age 70½ and you fail to take the appropriate minimum distribution for a particular year, there is a 50% penalty applied for the amount not distributed.

Resolving missed minimum distributions is a bit more difficult than the over-contribution, which can be a problem for inherited IRAs as well as an IRA owned by someone over age 70½.  This is especially true if you have missed more than one year of distributions, since each succeeding year depends upon the prior year’s distributions, and the calculations can get pretty messy.  See Unwinding the Mistake in the article at the link for more on how this is done. (The article applies primarily to inherited IRAs, but the method is the same for all excess accumulations, i.e., not taking timely distributions.)

Neither of these rules has a statute of limitations, so if your account is in error by one of these rules, you should take steps to resolve it as soon as possible – delaying further will only increase the penalties and interest charges.

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RMDs Don’t Have to Be Taken in Cash

Roseanne Cash

But…

It’s a little-known fact that distributions from an IRA  or a Qualified Retirement Plan can be taken in kind, rather than in cash.  You can in any circumstance take distribution from the account of stocks, bonds, or any investment that you own, just the same as if it were cash.

The downside to this is determining valuation for the distribution.  You could value the distribution on the day of the distribution by opening price, closing price, average price, or mean between the day’s high and low prices.  Where you really get into trouble is when the security that you own is very thinly-traded, such as a small company or very infrequently-traded bonds.  These can be very hard to value on the date of distribution, and as you might recall, the value of a distribution for Required Minimum Distributions (RMDs) must be valued appropriately in order to ensure that the minimum has been met.

In general, it is probably in your best interests to take the distribution for RMDs in cash – so that valuation isn’t an issue at all.

There Can Be An Upside

In some cases, especially where the securities held are more easily valued, it can be beneficial for you to take these distributions in kind.  By doing so, you will have the advantage of remaining fully-invested (no lag time between selling the holdings in one account and purchase in the new account).  Then there’s the obvious situation where you are hoping to use NUA treatment – those distributions must be in-kind (but NUA treatment doesn’t generally apply with RMDs).  You also would achieve the benefit of not having to pay commissions on the sale and purchase of the securities, if these would happen to apply in your case.

Another situation where taking a distribution in kind can be useful is precisely the one we described above as a negative.  If the security is hard to value due to some limiting factor such as light trading, you could take a distribution of an applicable percentage of the security, along with cash representing the appropriate percentage from the remainder of the account and thereby satisfy the RMD.  Later, when the security becomes more easily valued (such as maturity for a bond) you can sell the security for cash as needed.

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What is Meant by Half Years of Age?

fireworks

If you’ve paid much attention to the rules around retirement plans (IRAs, 401(k)s, and others), you’ve probably noticed that there are a couple of rules that refer to ages that include “½”.  So what does this mean??

Well, quite literally, this means 6 months after you reach a certain age.  The two primary ages with “½” included are 59½ and 70½.  So, to be age 59½, means that you reached your 59th birthday six months prior to that date.  Likewise, to be age 70½ means that you reached age 70 six months prior to that date.

These two ages are for different purposes and are (naturally) treated differently.

Age 59½

The rule using age 59½ is for one of the exceptions to the penalty for early withdrawals from your IRA or 401(k) plan: once you’ve reached that age (and not before that age) you can take withdrawals from your IRA or 401(k) plan without limits (401(k) plans may also require a separation from service).

Here is an important point: this rule is specifically applied ONCE YOU REACH AGE 59½, and not before.  In the year that you will reach this age, any withdrawals taken from the account before you reach age 59½ will be subject to the 10% penalty if no other exceptions apply.

Age 70½

The rule using age 70½ is regarding Required Minimum Distributions (RMD), as well as limiting contributions to an IRA.  For RMDs, the requirement is simply that you must begin taking the required distributions for the year in which you’ll reach age 70½.  (You can actually delay the first distribution until April 1 of the following year, but the distribution is based on the year when you reach age 70½.)

Note that this is different from the way the 59½ rule works: it’s simply the year in which you’ll reach age 70½, not the specific date that you reach age 70½.  So if your birthday is between January 1 and June 30, your age 70½ year is the year that you reach 70 years of age.  If your birthday is between July 1 and December 31, your age 70½ year is the year that you’ll be reach 71 years of age.

The same holds true for contributions to an IRA: in the year that you’ll reach 70½, you are not allowed to make contributions, and you are not allowed to make contributions thereafter.

You Don’t Have to Count Days

The good news is that you don’t have to count days.  For the purposes of these rules, the half year is the same date, six months later.  For a birthdate of May 11, the half year is reached on November 11 of that same year.  For odd circumstances, such as August 31, of course you’ve reached the half year on February 31 of the following year.  Actually, I believe the rule is that you reach that milestone on March 3 – I’d use this date if you are in this situation, just to be certain.

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Required Minimum Distributions (RMDs) Don’t Have to Be in Cash, But…

Kinder surprise
Image by Nerea Marta via Flickr

Here’s something that I bet you’ve never run across – when you have to begin taking Required Minimum Distributions (RMDs) from your IRA or Qualified Retirement Plan (QRP), most folks think you must take these distributions in cash.

This is not the case, you can actually take distributions of any sort, not just RMDs, from your plan (IRA or QRP) in either cash or “in kind”.  By “in kind”, this means that you can take the actual securities (stocks, bonds, or other investments) from the account.  These distributions in kind can be used to satisfy your RMD for the year.  There can be both pros and cons to taking distributions in kind.

Pros in favor of in-kind distributions

You might want to consider using an in-kind distribution if your IRA or QRP is fully invested and you want to keep it that way.  Sometimes (such as in a market downturn) it can be beneficial to maintain a cash position, but generally it’s often in your best interest to remain fully invested.  Using an in-kind distribution will allow you to remain fully invested before and after your distribution.

Another reason that you might want to use an in-kind distribution is if you have a particular position in a stock (for example) that you consider to be undervalued, such that it will appreciate considerably after you’ve distributed it.  This would put you in a position to have your gain (beginning with the date of distribution) taxed at capital gains rates rather than ordinary income tax rates.

In this second case you need to understand that you’d be taxed at ordinary income tax rates on the value of the distribution (on the day of the distribution) and your basis in the position will be set at that value.  Future gains will be considered against that basis.

In addition, if you don’t have to cash out of a position in order to distribute it, you wouldn’t incur a trade commission.  Assuming that you would just re-invest in the same or a similar security, you’d then incur another trade commission when you made the new purchase.  So distributing in-kind can cause a double commission to be paid, which may not be necessary.

Cons against in-kind distributions

Sometimes it can be difficult to value a security – for example if it is very thinly-traded.  In a situation such as this, distributing the RMD in-kind can cause difficulties, especially if you’re hoping to minimize the distribution to only the required minimum.

With this in mind, in order to reduce confusion and ensure that you’re taking exactly the correct amount in your RMD, it can be prudent to maintain or create a cash holding that will be sufficient for your RMD.

Taxation

It’s important to keep in mind that no matter how you take your distributions, you’ll have to pay ordinary income tax on the distribution – and the tax may be pro-rata if the IRA is partly non-deductible.

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Forget your RMD? Here’s What to Do

If you have an IRA that you have to take Required Minimum Distributions (RMDs) from, you need to do this every year by the end of the year.  So what if you forget one year?

Forget-me-not
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The rule is that if you don’t take your RMD by the end of the year, you could be subject to a penalty of 50% of the amount of the RMD.  If you’ve realized your error before the IRS has notified you, there are a few things you can do to try to resolve the situation.

The very first thing you should do is immediately withdraw the RMD in the amount that you should have in the previous year.  Contact your IRA custodian and request the distribution as soon as possible.

Then, if you’ve already filed your tax return for the previous year, fill out an amended return (Form 1040X), and include a properly filled out Form 5329.  If you haven’t filed yet, go ahead and file the Form 5329 with your regular Form 1040 return.

Form 5329 is the form that you use to report additional taxes on your IRA accounts – in this case you’re reporting the fact that you “overaccumulated” by not taking your appropriate RMD.  Include a letter with the return, asking for a waiver of the penalty, explaining that you forgot the RMD but as soon as you realized it you corrected your error by taking the distribution.  The IRS may let you off the hook – it’s easier for them to do this for taxpayers than to hunt you down and send you a bill.

It’s not fool-proof, but it’s the best chance that you have at this stage.  And then figure out a way so that you don’t get into this position again in the future.  For example, set up an automatic distribution plan by having an adequate amount sent to you monthly or quarterly.  Make sure that you adjust this annually to match that year’s RMD.  This way maybe you won’t have this problem next time around.

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Required Minimum Distributions for IRAs and 401(k)s

This is one of those subjects that can be a bit confusing – and it’s based on the rules that apply to the different kinds of plans.  You are aware that you’re required* to begin taking Required Minimum Distributions (RMDs) once you reach age 70½ – but did you know that specifically which account you take the RMD from has some flexibility?  Well – not just flexibility, also some rigidity…

You Alone  amongst all  the Thousands....... m...
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There is a Difference Between IRA and 401(k)

Starting off, we need to understand that, in the IRS’s eyes, there is a big difference between an IRA and a 401(k).  For brevity, we’re referring to all sorts of Qualified Retirement Plans, such as 403(b) or 457 plans, as 401(k) plans. You may consider the two things to be more or less equal, but if you think about it, there are considerable differences between the two – amounts you can fund the account with each year, catch-up arrangements, who can defer funds into each kind of plan, and the list goes on.

A 401(k) plan, being an employer-provided retirement plan, has a completely different set of rules governing it – including provisions that go all the way back to the original ERISA legislation.  Among those rules are the rules about RMDs.

On the other hand, the IRA is not covered by ERISA, and as such there are other rules that apply to these arrangements – including the RMDs.

We don’t have nearly enough space here to go over everything that is different between these two types of plans, but we’ll cover the RMD treatment fairly well.

Required Minimum Distributions (RMD)

Each and every 401(k) plan that you own is treated as a separate account in the eyes of the IRS.  As such, if you have four old 401(k) plans when you reach age 70½, you will have to calculate and take a separate RMD from each 401(k) plan that you have.  In other words, you couldn’t aggregate all the plans together and take one RMD from one of the accounts that is large enough to cover all the RMDs.  In addition, you have to consider each account separately and figure out how much of each RMD is taxable, if you have post-tax dollars in the account(s).

However, no matter how many IRAs that you have, since the IRS looks at these plans as one single plan, you are allowed to pool all of the account balances together, calculate the RMD amount, and then withdraw that amount any single IRA account or any combination of accounts.  Your tax basis is aggregated as well, so the tax treatment is a consideration for the entire pool of your IRAs in total (rather than account by account as is the case with 401(k) plans).

Example

You have two old 401(k) plans and three IRAs.  This is your year, you’ve reached age 70½, so you have to start taking RMDs.  How do you do it for these five accounts?

Each 401(k) plan has to be calculated separately – and a RMD taken directly from each account.  But you can pool the IRA account balances together and take one RMD from one of the accounts that is large enough to cover all three accounts’ minimum distribution.

This is another reason why it can be helpful (from a paperwork standpoint, if nothing else) to rollover your old 401(k) plans into IRAs.  By doing this, you don’t have to take a distribution from, in the case of the example above, three different accounts at a minimum.

* One final note: if you are still working at and after age 70½ and your 401(k) plan allows it, you may not be required to take RMDs from the account.  This is yet another difference between IRAs and 401(k)s with regard to distributions.

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