What are my options when satisfying my required minimum distribution?
One of the primary benefits of retirement accounts (IRAs, employer-sponsored plans, etc.) is that growth and earnings in the account are tax deferred; the funds are not taxed until they’re withdrawn.
However, the federal government only allows individuals to delay withdrawing funds for so long and eventually requires distributions in the form of “required minimum distributions,” or RMDs.
WHEN DO RMDS BEGIN?
The first required minimum distribution depends on the retirement account being considered.
IRAs (including SEP and Simple IRAs) — April 1 of the year following the calendar year in which you reach age 70½.
401(k), profit-sharing, 403(b) or other defined contribution plans — April 1 of the year following the later date of the calendar year in which you: 1) Reach age 70½ 2) Retire.
In the event that the individual is still working (for the entire year), the first distribution for the RMD from that current employer’s retirement plan is delayed until the year the individual actually retires. This applies only to that individual retirement plan (not IRAs or other/previous employer plans). If the employee owns more than 5 percent of the company for which the retirement plan is being utilized, he or she is still required to take an RMD (cannot delay).
For Roth IRAs, there is no RMD. However, if an individual has a Roth defined contribution plan, RMDs will still apply once that person reaches age 70½ (or later if the employee is still working). Ordinary income tax is due for all distributions, except in the case of Roth contributions, Roth earnings and after-tax contributions.
WHAT IF I DO NOT NEED THE INCOME FROM THE RMD?
In the case that income from the RMD is not needed, it may be beneficial to take the after-tax proceeds and re-invest the funds through a taxable account.
Federal Tax Withholding
RMDs can be useful when you’re considering how to cover your tax withholding for the year. Estimated tax payments are considered to be made in the quarter you send in the check; however, amounts withheld from IRA distributions are considered paid evenly throughout the year (even if they were made in a lump sum at the end of the year).
This is an opportunity to potentially defer paying estimated payments throughout the year and instead make a large lump-sum payment at the end of the year, in the form of withholding from your RMD. Keep in mind that this does not apply to state income-tax withholding requirements for many states. Before attempting this strategy, consult with a CPA.
Qualified Charitable Distribution
For individuals who may not need the income from the RMD and are charitably inclined, an attractive option could be a “qualified charitable distribution” (QCD). This type of distribution is made directly from an IRA to a public charity.
The distribution itself will not be treated as taxable income to the individual and will also satisfy any RMD obligations for that year. The maximum dollar amount for a QCD is limited to $100,000 per year or $200,000 for a married couple ($100,000 from each individual’s IRA). In order for the distribution to be qualified, the IRA cannot receive any kickbacks from the charity or “quid pro quo” benefits.
Taking a proactive step in managing and determining the appropriate RMD amounts can help you avoid costly errors. In some cases, penalties of up to 50 percent of the RMD may be applied. For those who are looking to defer withdrawals from retirement accounts or do not need the income, it is helpful to work with a financial advisor to determine the most appropriate strategy.