Every retiree wants to trim taxes, and maximize benefits.
But very few know how to approach this the right way.
Today, I’ll share how you can maximize your benefits from Required Minimum Distributions (RMDs), and reduce your tax bill.
Required minimum distributions from IRAs weren’t simplified or changed in the new tax law.
Taxpayers ages 70½ and older still have to take these distributions from traditional IRAs and other qualified retirement plans, 401(k)s included… whether they need the money or not.
The good news is we still have strategies to simplify RMDs and reduce taxes on them.
Required Minimum Distributions are taxed as ordinary income at an individual’s highest tax rate.
So, missing opportunities to reduce RMDs can be expensive.
More importantly, the penalty for computing your RMD wrong is perhaps the highest in the tax code.
You pay 50% of the amount you should have distributed — but didn’t.
That’s why finding Required Minimum Distributions mistakes is a high priority for the IRS from the past few years… ever since they learned that many taxpayers either don’t take their RMDs or calculate them wrong.
These days computers are programmed to identify potential Required Minimum Distributions mistakes…
Which is why managing the RMDs is an important part of retirement and tax planning after age 70½.
1. Know the RMD exceptions
Not everyone has to take RMDs from every qualified retirement account after age 70½. It’s important you do your research and know the exceptions to see if you qualify.
2. Computing RMDs
Most people don’t need to compute their Required Minimum Distributions anymore. Financial services firms generally are required to send you a statement early in the year that calculates your RMD for the current year.
It is easy to check the calculation or compute the RMD yourself.
Start with your IRA balance on Dec. 31 of the preceding year. For 2018 RMDs, use the IRA balance on December 31, 2017.
In free IRS Publication 590-B (available on the IRS website), turn to the life expectancy tables in the back.
Most people use Table III. A married IRA owner whose spouse is more than 10 years younger and is the primary beneficiary uses 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.
It’s important that you do this exercise every year. You can always take out more than the RMD after age 70½. But you must take at least the Required Minimum Distribution amount.
3. Aggregating RMDs
When you have multiple IRAs, calculate the RMD for each IRA.
Then, you can add the individual RMDs to arrive at one aggregate RMD for the year.
You can take the aggregate RMD from the IRAs in any combination you want.
Take it all from one, pro rata from each, or in any other combination you want.
Some people use the Required Minimum Distributions to rebalance their overall portfolios.
When different IRAs have different beneficiaries, some people use RMDs to equalize IRA values.
Some people take all their RMDs from one IRA until it is exhausted, and then move to another IRA.
Over time, that simplifies their lives by reducing the number of IRAs.
However, the aggregation rule applies only to traditional IRAs. You can’t aggregate different employer retirement accounts or inherited IRAs.
Their Required Minimum Distributions have to be separately computed and taken.
4. In-kind distributions
Most people think RMDs have to be cash distributions.
They sell assets, perhaps incurring trading costs, and distribute the cash.
There’s no need to sell assets to make RMDs, because distributions don’t have to be in cash. Your IRA can distribute assets.
For example, when your IRA custodian is a mutual fund or broker, it’s usually easy to direct the custodian to transfer shares of a mutual fund or stock from the IRA to a taxable account.
Most of the time this can be done through the website or over the telephone.
There usually is no fee for the transfer, and your portfolio allocation doesn’t change.
The fair market value of the asset on the day of the distribution is included in your gross income and counts toward your Required Minimum Distribution.
It also is your tax basis of the asset. So, if you sell it in the future, you owe capital gains taxes only on the appreciation after the distribution.
The in-kind distribution is valuable when your IRA owns unconventional assets, such as real estate, mortgages, or a small business.
You might avoid selling the asset by transferring legal ownership of a portion of the asset from the IRA to you.
But in some cases, the cost of transferring legal title each year can be burdensome.
With real estate, for example, you probably need to have a new title or deed drawn up and recorded every year.
Another handicap is the valuation. When the asset isn’t publicly traded, you need an appraisal or other method to establish the value.
You want to deter the IRS from challenging the valuation and imposing the penalty for failure to take the full Required Minimum Distribution.
Next week: I’ll share five more RMD strategies to maximize your benefits, including how to time the first RMD and the distributions, and how to avoid the RMD waterfall.