IRAs and RMDs: When can more mean less?

While we know there is an absolute in which we cannot change with estate planning, what we can change with careful consideration, is the ability to hopefully lessen your estate's tax hit on individual retirement account required minimum distributions (RMD). At age 70 ½ you’re required by law to begin making a RMD from a traditional, SEP; or SIMPLE IRA. No RMD is required of a Roth IRA because it only becomes taxable at the owner’s death.  Whether you’re still working when you hit RMD age is irrelevant: you must begin making distributions, which typically are treated as taxes paid on ordinary income.

The government doesn’t want you sitting on that money because as you do, it can’t be taxed.  Therefore, while government is giving IRA-related tax breaks, it’s taking away – or making sure it gets its cut – through RMD. The RMD amounts change as you age. Figuring it out takes a bit of work. The IRS information page on the worksheet with which to calculate your RMD can be found here.  

After turning 70 ½ you must make your distribution by April 1 of the next year, but you don’t have to actually take possession of the money until Dec. 31. And there are date-juggling methods that enable you to delay your first RMD, though the result of making multiple distributions in a single year may push you into another tax bracket.

Getting the RMD amount and dates of distribution right are crucial.  The IRA owner is ultimately responsible regardless if he or she uses an IRA administrator or custodian, and penalties for miscalculating or being late can be up to 50% of the amount that should have been distributed in addition to the federal and state taxes.  

Taxpayers sometimes think the RMD must come from a specific IRA, but that’s not the case. If you have multiple IRAs you can take a small amount from each one to make the RMD.

To the degree your IRA grows in value, your payouts increase.  The tax hit becomes greater with the passing of time. Again, these amounts are taxed as ordinary income. As the IRA’s assets grow, and the distribution percentages increase, it can raise your income and push you into the next tax bracket. An alternative is to take a larger-than-required RMD. Taking a distribution just below your existing tax bracket avoids taxation at the higher level. The payout will reduce your IRA more quickly, which also means the total will be less for the IRS to tax. 

Another strategy: convert to Roth IRAS, in whole or part, because while Roth IRA income is subject to the estate tax, it’s not taxed as ordinary income. It’s not necessary to wholly convert: partial conversions are allowable.

Another thought: invest distributions in capital gains property with all future gains taxed at lower capital gains tax rates. The goal is to pay taxes at the lowest possible rate, not defer or delay tax payments.

The rules, regulations, variances, waivers, exceptions and related RMD issues are many and complex. It’s essential to have expert financial or accounting counsel to decide whether to make minimum (to limit IRA depletion) or larger-than-required distributions to avoid higher brackets.

That’s because if you can avoid it, it's good not to have tax brackets to creep up on you.

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Tagged IRA, Taxes, RMD, Tax