Optimizing RMDs from IRAs

It is time for many individual retirement arrangement (IRA) owners to consider carefully their required minimum distributions (RMDs). When you’re older than age 70½, you have to take RMDs from IRAs and other qualified retirement plans each year. The IRS realized a few years ago that many people were calculating their RMDs wrong, or not taking them at all, so it recently increased the attention it gives to RMDs.

RMDs are a simple concept, but of course Congress and the IRS make rules that create both opportunities and potential pitfalls. Remember RMDs for owners apply only to traditional IRAs. Roth IRA owners don’t have to take RMDs (but beneficiaries of both types of IRAs have to take RMDs).

Here’s the simple part. To compute your RMD for 2016, add the December 31, 2015, account balances for all your IRAs. Then go to IRS Publication 590-B, available free on the IRS web site at www.irs.gov. In the back of the publication are the life expectancy tables. Most people use Table III; married people whose spouses are more than 10 years younger than they are use Table II. Beneficiaries use Table I. Look up the life expectancy factor for your age in the appropriate table. Divide the total IRA value by the life expectancy factor. The result is your RMD for this year. You perform this exercise every year.

Here are some key points and strategies to consider when planning your RMDs.

Using multiple IRAs. Most people have more than one traditional IRA. As part of your estate planning and RMD planning, consider if you want a different number of IRAs than you currently have. The law allows you to combine or split IRAs without any tax consequences. It is best to make any changes with direct trustee-to-trustee rollovers instead of trying to transfer the money yourself.

There are good reasons for some people to have multiple IRAs.

When you have more than one beneficiary, you might want to maintain a separate IRA for each beneficiary. Sure, the beneficiaries could inherit one IRA jointly and split it tax-free after inheriting. But you might decide to act now to make their lives easier.

There are potential disadvantages to splitting an IRA. One is that life becomes more difficult for you, because you’re managing multiple IRAs. Another is the investment returns and distributions from the IRAs might be different, so the beneficiaries might not inherit the same amount unless you move money around to equalize their values.

Another reason to consider multiple IRAs is to segregate some different types of assets. For example, you can buy a qualified longevity annuity contract (QLAC) in an IRA, and RMDs aren’t required from that portion of the IRA until age 85. Your life might be simpler if you establish a separate IRA that holds only the QLAC. Also, an IRA that was created by a rollover from a 401(k) has greater creditor protection than some other IRAs. You might want to continue to have this IRA separate from others.

Which accounts to draw down. You compute the year’s RMD by aggregating all your IRA balances. But you can withdraw the RMD from your IRA accounts in any proportion you want. All of the RMD can be taken from one IRA. You can take roughly equal amounts from each IRA. Or you can take the amount from the IRAs in any other ratio you want. The only requirement is that by Dec. 31, your total distributions from your traditional IRAs at least equal your RMD for the year.

Some people use the RMD requirement to rebalance their investment portfolios. Suppose one IRA holds more U.S. stocks than another, and U.S. stocks had a very good year. They performed so well that your overall portfolio now has more stocks than you want. You can take the RMD from the IRA that has the most stocks. That both satisfies your RMD and rebalances your overall portfolio.

The form of your distribution. Your RMD doesn’t have to be made in cash. There’s no need to sell an asset to make the RMD. You can take the RMD in property, known as an in-kind distribution. For most IRAs, this involves simply directing the custodian to transfer a certain number of shares of a mutual fund or stock from the IRA to a taxable account. You have to be sure the value of the shares when distributed is at least equal to your RMD.

The in-kind distribution is especially helpful when you own unconventional assets in an IRA, such as real estate, mortgages, or a small business. It’s hard to break up such assets and sell only a portion of them to make the RMD. Instead, make an in-kind RMD by transferring the title to a portion of the asset to you.

Timing distributions. You can take the RMD at any time during the year. Some people schedule monthly distributions that at least equal the RMD, because they like the regular cash flow. Others take their RMDs early in the year to be sure the task is done. Others wait until the end of the year. They want to maximize tax-deferred gains and income, and they want to delay paying estimated taxes on the distributions.

T. Rowe Price did a study a few years ago comparing RMDs taken at the end of the year to those taken early in the year. It found that the IRA lasted longer when RMDs were delayed until late in the year. But the study was done using a period when the stock market was steadily rising. The result would be different in a declining market or if the IRA were invested differently. It also probably doesn’t matter much if you take in-kind distributions. You have to decide which strategy is best based on your goals and strategies.

Charitable exclusion RMDs. In late 2015, Congress finally made permanent the IRA charitable gift exclusion. Each taxpayer age 70½ or older can have charitable contributions made directly from an IRA to a charity. The contribution has to be made directly by the IRA custodian to the charity. The charitable contribution is excluded from the taxpayer’s gross income and it counts toward the RMD for the year. The taxpayer receives no charitable contribution deduction. The limit on the exclusion is $100,000 per taxpayer per year. A married couple potentially can donate $200,000 this way, but each spouse must give $100,000 from his or her own IRAs. See our May 2016 issue for details about the strategy.

First-time RMDs. Be sure to include all IRA account balances when calculating the RMD. For this purpose, IRAs include SEP and SIMPLE IRAs. Balances of inherited IRAs and any employer plans, such as 401(k)s, are not included with the other IRAs when computing the RMD. The RMDs for those other accounts are each computed and taken separately.

The first RMD has to be taken by April 1 of the year following the year you turn age 70½. If you turned 70½ in June 2016, you have until April 1, 2017, to take that first RMD. But it is considered your 2016 RMD, and you probably want to take it by December 31, 2016. Otherwise, in 2017 you have to take that 2016 RMD plus your 2017 RMD. That gives you two RMDs in one year and could push you into a higher tax bracket. (You use the December 31, 2015, account balances to calculate the first RMD, regardless of when you take it.)