Required minimum distributions (RMDs) are mandated withdrawals from qualified retirement plans and IRAs after you have reached the age of 70½. Miss one or don't take enough out of your account and a 50 percent penalty applies. While the IRS requires these distributions, that doesn't mean you can't plan to use it to your benefit.
First year flexibility. In the first year of your RMD you get some flexibility in which year you want to be taxed on the distribution received. Every year after the first RMD, you must take your distribution before December 31. However, the very first RMD must be taken by April 1 of the year after which you attain the age of 70½. You have the ability to shift income from one tax year to the next for whichever situation results in the lowest tax liability.
Investment selection and rebalancing. You may have multiple IRAs and have multiple beneficiaries for them. You must compute the RMD for each IRA account, but the IRS allows you the option to take all of your computed RMDs from one account or split between them as you see fit. The important part is that the sum of the computed RMDs are taken. So if you have poor performing investments in one account, you could elect to cash those in and use those funds for your RMD. Or if you have multiple beneficiaries of different IRAs, you can rebalance those accounts by taking more of your RMD from one account to bring it in line with your estate plan.
Charitable planning. The IRS allows taxpayers to utilize their RMDs for what is called a qualified charitable distribution (QCD). This is essentially a charitable donation that is made directly from your IRA. The amount can be as much as $100,000 and is not included in your income. This is even a better benefit if you no longer itemize your deductions for return purposes. The added indirect benefit of a QCD is that it reduces your adjusted gross income (AGI) because it is no longer income to you. This reduction in AGI can cause less of your Social Security to be taxable, can keep you in a lower tax bracket or allow you to claim a tax credit you may otherwise not have qualified for.
Tax estimates and withholding. The IRS treats withholdings differently than tax estimates. A tax estimate is credited to the quarter in which it is received (or the due date it relates to), while withholdings are presumed to be made ratably over the entire year. If you missed an earlier estimate payment or could not submit the full amount at that time, you can use the withholdings from your RMD to make up the difference (even if the RMD is made on December 31). This may allow you to get out of the penalty for underpaid estimates or late payments.
Long-term income planning. While RMDs are required when you reach the age of 70½, you are eligible to take retirement distributions (in most cases) at any point after reaching age 59½ (so as to not be subject to early withdrawal penalties). If you know that you will be in a much lower tax bracket in a given year versus when you are of RMD age, you can take a distribution earlier to help reduce taxes in later years. Another strategy is to utilize distributions from your IRAs to replace Social Security benefits in the years before your RMD. Delaying the age when Social Security benefits are started can increase your benefit by up to 32 percent per year for the rest of your life.
Required distributions are a fact that many of us will have to deal with, but taking the time to best utilize this source of income can provide planning opportunities that can help save you taxes. You should discuss these opportunities with your financial planner and tax professional to make sure you take advantage of what Uncle Sam requires. Contact us in one of our many locations.
Wednesday, April 24, 2019 | 7:30 AM – 9:30 AM EDT | The Hartford Club