When you invest in an IRA, or other tax deferred plans like a 401(k), you delay taxes on that income (subject to limits) and growth until you start to make withdrawals.
As of the August 2019, you can start to make penalty free withdrawals at age 59-1/2 (some distribution reasons can be additional tax penalty free prior to age 59-1/2) and you are currently required to take distributions (Required Minimum Distributions – RMD) the year you turn 70-1/2. There is talk to increasing the RMD age to 72-1/2 currently.
The calculations can be complicated, and the penalties for not taking the RMD are steep: If you don’t take the required minimum distribution by the deadline each year, you’ll pay a penalty of 50% of the amount you should have withdrawn.
Considering the withdrawals will be taxed as ordinary income, the prospect of the tax bill can be scary. You need to know the strategies you can use to minimize taxes and avoid mistakes.
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Calculate the Amount of Your RMD Withdrawals
Your RMDs are based on the balance in your accounts as of December 31 of the previous year, divided by a life expectancy factor based on your age. You can use the Uniform Lifetime table (Table III) in Appendix B of IRS Publication 590-B on the IRS website. If your spouse is more than 10 years younger than you and is your sole beneficiary, use Table II, the Joint Life and Last Survivor table, for the life expectancy factor.
IRAs are owned individually, even if you’re married and file a joint tax return, so you and your spouse have to take your RMDs from your own accounts.
Most IRA or 401(k) administrators will send you the required minimum distributions each year also.
Choose the Accounts of Your RMD Withdrawals
You have to calculate the RMD from each of your traditional IRAs, including rollover IRAs, SEP or SIMPLE IRAs. But you can add the total required withdrawals from all of those IRAs and take the money from any one or more of the IRAs. You cannot take RMDs for a 401(k) from your IRA.
I would choose accounts with high fees or exceed SIPC insurance balances first. Limited investing options (high concentrations) are another possible reason to withdrawal first too. Most insurance companies and banks offer IRAs, but allow you to invest in the company or interest savings only.
Choose Which Investments to Withdrawal
Some IRA or 401(k) administrators automatically withdraw RMDs proportionately from each of your investments, unless you specify otherwise, and they could end up selling stocks or funds at a loss to make your payment. If you’d like to prevent that from happening, you can usually elect to take a fixed percentage from each of your investments or have 100% taken from cash. If you choose the cash option, the IRA administrator may send you an alert beforehand in case you need to sell shares to raise the cash.
I am the conservator of an estate that has an IRA through Edward Jones, I use the cash option and convert certain investments annually to cash to meet the RMDs.
Time Your Withdrawals
You usually have to take your annual RMD by December 31 of the year your turn 70-1/2, but you have until April 1 of the year after you turn 70 to take your first required withdrawal. However if you delay the first withdrawal you will have to take two RMDs in one year (one by April 1 and the other by December 31), which could create a large tax bill. The additional ordinary income could cause more of your Social Security benefits to be taxable, put you in a higher tax bracket that includes surcharges, etc.
You Can Choose to Automate Your Withdrawals
If you’re worried about missing deadlines, most IRA administrators will let you automate your RMDs. You can usually sign up to have the money withdrawn every month on a certain date each year.
Have Your RMD Go to a Charitable Organization
You can get a tax break donating your RMD to a charity. After you turn 70-1/2, you can transfer up to $100,000 directly from your IRA to charity each year (called a qualified charitable distribution), which counts toward your RMD but isn’t included in your adjusted gross income. This strategy can be particularly helpful now that fewer people are able to itemize their deductions due to the Tax Cut and Jobs Act and otherwise wouldn’t get a tax break for their charitable gifts.
You can make the transfer to one or more tax-qualified charities. The transfer must be made directly from your IRA to the charity to count as a QCD. If you receive the money first, the distribution will be taxed as income and you will have to itemize to get credit for the donation. The benefit is greatly reduced in that situation.
Consult with your IRA administrator about their procedure. Most send the money directly from your account. Let the charity know the money is coming so they can send you a confirmation, which you’ll need to keep with your records and give to your tax return preparer, along with the 1099-R you will receive around February of the month following the distribution year end.
Roll your Traditional IRA RMD into a Roth IRA
You do not have to take RMDs from Roth IRAs, so any money you have rolled over from a traditional IRA to a Roth avoids future RMDs. You will still have to pay taxes on the amount you rolled over (withdrew.) Take that into account, you may need to withhold some of the rollover to pay your estimated taxes. If you choose to rollover before 70-1/2, consider what amount you can afford the tax on to rollover each year.
Invest in a QLAC
Balances invested in a Qualified Longevity Annuity Contract (QLAC) is not included in the RMD calculation. You can invest the lessor of 25% of the balance or $130,000. I would look at this option closer to retirement age, but before 70-1/2. You’ll pick the age you want to start receiving an annual benefit for the rest of your life. The benefit is based on actuarial tables, but you will need to factor in your own health and family health history and access to quality medical care. You must start receiving the benefits at age 85 if you do not choose earlier.
You don’t want to start receiving lifetime benefits at age 72, only to drop dead at 73.
I hope this post helps you in considering your options in withdrawing from your IRA. If you need help preparing your tax return, please email me at ValdostaCPA at Yahoo.com. Personal 1040 tax returns with 1 State start at $100. Many of my retired clients do not exceed that fee. I can prepare remotely, you just need either a scanner or smart phone to get paperwork to me (although some clients elect to mail everything.)
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