So – you’ve reached that magic age, 70½, and now (well not now, IRS granted a reprieve for 2009) you’ve got to begin taking the dreaded Required Minimum Distributions (RMDs) from your various retirement accounts. Listed below are a few tactics that you might want to employ as you go through this process. Perhaps one or another will make the process a little less onerous on you.
5 Tactics for Required Minimum Distributions
1. Take all of your RMDs from your smallest IRA account.
If you have several IRA accounts, you can aggregate the amount of your RMD for the year and take it all out of one (presumably the smallest) account. This way you’ll eventually eliminate that extra account, and reduce paperwork, time, and error in calculating RMD amounts and complication in estate planning.
The same can be done for your 403(b) accounts, but you can’t use IRA distributions to make up your 403(b) RMDs or vice versa. Each type of account must have its own distributions. This does not apply to 401(k) accounts, though: each 401(k) has its own separate RMD.
Keep in mind though, that distributions from an inherited IRA or inherited 403(b) can not be used to satisfy the RMD for your other, regular IRAs or 403(b)s.
2. Take distributions in kind, rather than in cash.
There is no requirement that your RMD must be in cash – so if the situation is advantageous to you, you might consider taking the distribution in stocks, bonds, or any other investments to fulfill the RMD requirement. When the distribution occurs, the value of the investment is considered taxable income to you – and therefore becomes the new basis of that investment.
There are three situations when this type of distribution is particularly useful:
a) If you wish to remain “fully invested”, you will save on commissions since you don’t have to sell the investment inside the IRA, remove the cash, and the re-purchase the same investment in your taxable account.
b) If you hold a stock that you believe is undervalued and expect to appreciate in value, transferring it outside the IRA gives you the ability to receive capital gains treatment on the appreciation. Even better, once outside the IRA, if you hold the stock until your death, your heirs will receive the stepped up basis of the stock as of the date of your death, bypassing tax altogether (depending upon the size of your estate, of course).
c) If you hold an investment that is particularly difficult to value, such as a thinly-traded stock or a limited partnership, you can take a portion of the distribution from this holding (e.g., if you’re required to take 5% of the account, take 5% from the LP and the rest in cash or whatever else the account holds). This way you don’t have to come up with a value of the difficult to value holding each year when taking distributions.
3. Take your distribution early in the year. No wait, take it late in the year.
There are arguments on either side of the issue, but in general I agree more with the benefit of the latter statement, which I’ll explain in a moment.
Taking the distribution early in the year is most helpful for your heirs. If you happen to pass away during the year and have not yet taken the RMD, your heirs will need to make certain that the RMD is taken before the end of the year – at a time when they aren’t necessarily thinking about this sort of thing.
On the other hand, taking the distribution later in the year provides you with the opportunity to take advantage of any rule changes that Congress tosses your way through the year. For example, in 2009 you don’t have to take an RMD at all, and if you did you get to roll exactly one distribution back into your IRA by 11/30/09. Similarly, in 2006 and again in 2008 there were the late-in-the-game rule changes that allowed the IRA holder to make distributions directly to a Qualified Charity, so that the income was never factored into the tax return at all (an advantageous thing, especially with regard to Social Security taxation calculations, for example).
So, all in all, I think it’s better to wait – at least until the first half of the year is over – before taking the RMD. Besides, your heirs will get over it.
4. Take extra distributions (more than the RMD) when your income is lower.
This is similar to the “Fill Out The Bracket” strategy that I’ve written about before. Essentially you look at your available tax bracket (especially if you are in the lower brackets) and take out extra distributions up to the maximum in your applicable bracket. This will reduce your RMDs in future years, allowing you to either convert those funds over to Roth IRA accounts or a taxable account subject to the much lower capital gains rates.
5. Take extra distributions when subject to AMT.
This is mostly useful if you are normally subject to the highest tax brackets (35% these days), but for other reasons you find yourself subject to AMT. You can take additional distributions from your IRA up to the limit that keeps you in the AMT tax, and these funds will only be taxed at a 26-28% rate. These distributions could either be taken as income or converted to a Roth IRA. (Note: bear in mind that if the final calculation shows that you’ve taken too much from the IRA and kicked yourself back into the 35% bracket, you’ll have to work quickly to get the excess rolled back into the IRA account. The Service doesn’t have any sense of humor about allowing extensions of the 60-day rollover period in cases like this. For this reason it would be prudent to not try to maximize this benefit.)
Photo by sergeant killjoy
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).