Sunday, June 14, 2015

When Should I Take My IRA RMD?


IRA owners who are over age 70 1/2 are required to take annual distributions from their traditional IRAs.
The RMD can be taken any time from Jan. 1 through Dec. 31 of the "distribution year." (For the age-70 1/2-year's RMD only, make that "Jan. 1 of the distribution year through April 1 of the following year.")

So what is the best time to take it within this time frame?
Monthly? Some retirees set up their IRAs to provide distributions throughout the distribution year, typically in the form of automatic monthly transfers directly from the IRA into the owner's bank account. The sum of the 12 payments will equal the RMD. This conveniently provides a regular income while also taking care of the RMD.
This method can cause problems in the year of the participant's death, however. For one thing, the automatic transfers may continue for a while after death has occurred, because the IRA provider does not learn instantly about the participant's death. This creates problems if the post-death payments go into a bank account that does not belong the participant's beneficiary. How will the beneficiary get this money back?
Another headache for the beneficiary is that he or she is required to take the balance of the RMD for that year of death to the extent it was not distributed to the participant during his or her life. See "Late in the year?" below for issues with a late-in-the-year death.
Early in the year? Taking the RMD early in the year has the great advantage of getting the thing over with, so the obligation is not hanging over your head all year. It's also thoughtful for your beneficiaries--see below regarding issues that otherwise arise with a late-in-the-year death. And needless to say, if you have an immediate good use for the money, such as making estate-reducing gifts or paying down debt, distribute sooner rather than later.
Early-in-the-year is also recommended for someone who is looking for ways to "shrink" the IRA in order to minimize future RMDs. Getting money out of that account earlier rather than later allows the net proceeds to be reinvested sooner in long-term gain-producing investments that will get a stepped-up basis at death, as opposed to helping to swell the IRA and its ever-increasing stream of taxable RMDs.
Late in the year? The retiree who takes the RMD late in the year is seeking some or all of the following advantages:
  1. The gross income generated by the distribution is not taxable until as late as possible. This is useful if you pay estimated taxes based on each quarter's actual income. Your first three estimated payments for the year would be relatively lower, with a spike in income in the final quarter (and a larger estimated tax payment due the following January). This factor does not matter if the required minimum distribution is a relatively small part of the IRA owner's annual income, or if the owner always pays estimated taxes based on last year's tax rather than bothering with computing actual income quarter-by-quarter.
  2. The longer the RMD stays in the IRA, the more tax-deferred income it can generate. Once the distribution comes out, future investment growth will be taxable as it is realized. This factor is a negative, however, if the IRA owner's "outside" investments generate long-term capital gain (where the taxable income is naturally "deferred" until sale) and he or she is actually looking for ways to shrink the IRA (see "Early in the year?" above!).
  3. You have a better chance of getting in on any tax rule changes that occur late in the year. The classic example is qualified charitable distributions (QCDs), the tax code section that allows older IRA owners to transfer up to $100,000 of cash per year directly from the IRA to a public operating charity. The transfer is not includible in gross income but does count toward satisfying the RMD requirement. Unfortunately as of right now, QCDs are not allowed for 2015...yet. At multiple times in recent years Congress has renewed QCDs at the very end of the year, retroactively for the entire year. Someone who has already taken his or her RMD before a new law is passed (or QCDs retroactively allowed) will lose that opportunity.
  4. If your benefits will pass at your death to a tax-exempt charity, and you do not need the RMD money for your personal purposes, it makes sense to delay as long as possible. If death occurs, the RMD will pass, along with the rest of the account, income tax-free to the charity, instead of being distributed to you and subjected to income tax.
  5. You can use the late-in-the-year RMD to actually pay your estimated taxes: Using Form W-4P, request the IRA provider to send most or all of the RMD amount directly to the IRS as withheld income taxes. Regardless of the time of year the IRS actually gets that money, income taxes paid via withholding are deemed to have been paid ratably throughout the year (unless you rebut the presumption). This technique saves the IRA owner a few dollars in the form of the interest he can earn on the money he otherwise would have sent to the IRS in April, June, and September to pay his estimated taxes.
The downsides of waiting until later in the year are, first, the nagging obligation, like an unpaid bill, that may or may not prey on your mind.
The second drawback affects only your beneficiaries, not you. The beneficiary must take the RMD for the year of your death to the extent it was not distributed during your lifetime. If your death occurs late in the year, and you have not yet taken the RMD, the beneficiary may have a very short period of time in which to figure out that he or she has inherited this IRA from you, that an RMD was required for the year of death, how much it is, and that you didn't yet take it. The beneficiary must then race over to the IRA provider to get that distribution out by year-end to avoid penalties. Presumably the beneficiary could get the IRS to waive the penalty if the death was really late in the year, but either way he is paying for his inheritance with a bit of stress.
Now two general tips:
  • The RMD must be paid every year. To avoid risking the stiff penalty for failure to comply, set up fail-safe systems and reminders so you don't forget. Use your own calendar and tickler systems, and make sure your accountant, financial planner, and IRA provider know they are also supposed to remind you about this.
  • If you are still working, keep contributing to retirement plans! Even if you are over 70 1/2, so you are no longer eligible to contribute to a traditional IRA, you can still contribute to a Keogh plan or other workplace "qualified" retirement plan. Continued contributions to such plans would give you useful tax deductions to offset the gross income from your minimum distributions and ongoing compensation income. You can even contribute to a Roth IRA if your income is under specified levels; that won't give you a tax deduction, but it will help bolster your retirement security.