Posted by Fred Lake

Unknown Rules & Strategies for RMDs (Required Minimum Distributions) from IRAs

Unknown Rules & Strategies for RMDs (Required Minimum Distributions) from IRAs

The required minimum distributions (RMDs) of IRA and other qualified retirement plans are more complicated than they should be. Several little-known rules can help or cause taxpayers to pay higher taxes or fines.

Most people believe that IRA stands for "Individual Retirement Account." But the tax code and the IRS call them "individual retirement arrangements."

The general rule of thumb for RMDs is that the owner (called a participant) of a traditional IRA, 401(k), or other defined contribution pension plan must start RMD by April 1 of the year after turning 72 years old. But if you turn 70 and a half before 2019, your first RMD must be taken before April 1 of the year after the age of 70 and a half. After the year in which you have completed 72 (or 70½ for those who completed 70½ before 2020), your RMD equivalent distributions must be made by December 31 of each calendar year.

Although the deadline for taking the first RMD is April 1, most people must take the first RMD by December 31 of the year they turned 72. This is because they will have to take the second RMD at the end of next year. Suppose they wait until April 1 to take the first RMD. In that case, they will have two RMDs that year, and this could push them into a higher tax bracket or increase the value of Social Security benefits included in gross income or increase the Medicare premium surtax, also known as IRMAA (Medicare's income-related monthly adjustment amount).

The penalty for not withdrawing the full RMD amount is 50% of the amount that the IRA should have distributed but was not. This penalty is added to the income tax when the distribution is finally made.

You can distribute more than the RMD value if you want or need the money. But the excess over the RMD will not be used as a credit or other reduction in the calculation of the RMD for next year. Next year, you'll use your IRA balance from December 31 of that year to calculate the RMD. This means you will indirectly get credit because taking a larger distribution this year decreases the IRA balance and decreases the RMD for the next year.

RMDs do not have to be taken out in a lump sum at the end of the year. You can take your RMD in any pattern you want. You can take fixed rates throughout the year or take distributions at regular intervals. Some people ask their IRA custodians to send them monthly checks for an equal amount that totals at least the RMD for that year.

When you have multiple IRAs, start by calculating the RMD separately for each IRA. Therefore, you have several options. You can get the calculated RMD for each IRA.

Or you can add all RMDs, known as aggregating. Then you can get the overall RMD of the IRA in the desired proportion. The full overall RMD can be obtained from an IRA. It can be obtained proportionally from each, or an equal amount can be obtained from each IRA. Or any other allowance that you think can be taken as long as the total is equal to the RMD added for that year.

Some people apply the aggregation method to rebalance portfolios or to simplify the management of their IRAs in the future.

For example, suppose a person has two IRAs, and one IRA has mostly high-priced stocks, and another IRA has other investments that haven't performed as well. The owner can take all the RMD from the IRA that mostly owns stocks. This brings the owner's total asset allocation closer to its level at the start of the year, so it is less overweight to stocks.

Other people decide to simplify their financial life by reducing the number of IRAs they have. Therefore, they remove all RMDs from an IRA until it is depleted and can be closed.

The aggregation method cannot be used with 401(k) if other accounts are related to employment. For them, the RMD is calculated separately for each account, and the RMD must be extracted from that account.

When you take an RMD, there is no need to sell an investment and distribute the money. You can ask the IRA to distribute stocks or mutual funds, or any other investment you own. You must ensure that the distributed property's value is at least equal to the RMD for the year. The value of the property on each distribution's date is used to calculate the value of the distributions for the year and is the value included in gross income. It doesn't matter if the property's value goes up or down after the distribution date.

Taking a distribution of property rather than cash ensures that your money stays invested until it's spent.

During a real estate distribution, the property's taxable basis is its fair market value on the date of the distribution. When you finally sell the property, you owe capital gain tax only for the valuation that took place after the distribution.

You can spend or invest RMD if the distribution is cash. RMD can be implemented after implementation.

Some people want to put their RMD in another traditional IRA or a Roth IRA. But there are restricted circumstances in which you can. First, if you enter RMD into another retirement account, there will be no tax-free transfer. You must include RMD in your gross annual income.

The RMD amount can be used to make a yearly contribution to an IRA if you meet the contribution requirements. A recent tax law abolished the ban on traditional IRA contributions after 70½. You can now contribute to a Traditional IRA or Roth IRA at any age.

But you can only contribute to the IRA to the extent that you have earned income during the working year or self-employment. Therefore, most people who receive RMD will not be able to contribute to a gainful IRA.

Also, the annual IRA contribution limit of $7,000 in 2021 applies to taxpayers over 50.

When you want to fully or partially convert a Traditional IRA to a Roth IRA, you must first take an RMD for the year before you can convert any amount.

A QCD (qualified charitable contribution) can count towards all or part of the RMD for that year but is not included in gross income. You can earn QCDs of up to $100,000 per year.


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Fred Lake
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