How to Take Required Distributions

Continuing our series of "life stage" articles, this month features more general tips on how to take required minimum distributions (RMDs) from your individual retirement accounts (IRAs).

Get the Basics Right Each year, the RMD is determined by dividing the adjusted prior year-end value of the traditional IRA by a divisor obtained from the appropriate IRS table. There are few IRS guidelines on how to value assets for purposes of determining that "prior year-end value." I recommend including accrued but unpaid bond interest in the account's value, even though the IRA provider's form 5498 (filed approximately May each calendar year for the prior year) may not do so. Valuations of hard-to-value assets should be supported by regular appraisals.

If a deferred variable annuity contract is held in the account, you can normally use its "cash value" as its value for RMD purposes; however, if the contract has a minimum death benefit guarantee in excess of that cash value, and the contract permits you to withdraw cash without reducing the death benefit, a different valuation rule may apply.

Add back into the prior year-end value (if applicable) the two required adjustments for assets that landed in the account after the prior year-end valuation date:

• Any rollover amount deposited in the account within 60 days after the beginning of the year that was "in transit" between IRAs on the year-end valuation date; and
• The amount of any Roth conversion in the prior year that was "recharacterized" in the current year.

There are two adjustments that could reduce the prior year-end value for purposes of the formula. First, exclude the value of permitted "true annuity" contracts then held in the account, including Qualified Longevity Annuities. Second--and I hope you don't get to use this one--if the total value of the account as of the date you distribute is less than the amount of the RMD as determined by the formula, the RMD is reduced to equal the total account value.

From Which Account? In some cases a distribution from one retirement account can be used to satisfy the RMD from a different account, but be very careful! Many people stumble on this rule and wind up owing penalties. Here are the very limited types of retirement accounts that can be "aggregated" for purposes of satisfying the RMD:

• If you have multiple traditional noninherited IRAs, a distribution from any one of them can count toward the RMD from any of the other traditional noninherited IRAs.
• Similarly, a distribution from a noninherited 403(b) plan can be used to satisfy the RMD from all of the participant's noninherited 403(b) plans.

Use this rule to, for example, eliminate a small account by taking all of the year's RMDs (for all your applicable accounts) from that one.

Now for the bad news. Here are the accounts that must pay their RMDs separately. For these plans, you must take each plan's or account's RMD from that particular account or plan:

• All qualified plans (e.g., a Keogh plan or 401(k) plan). Even if you have five separate 401(k) plans, each one must pay its own RMD each year. An IRA distribution can never satisfy the RMD requirement for a qualified plan and vice versa.
• Roth IRA distributions do not count toward required distributions from traditional IRAs.
• And vice versa! Attention beneficiaries: A distribution from an inherited traditional IRA does not count toward the RMD from an inherited Roth IRA.
• Distributions from inherited accounts do not count toward the RMD from your own account.
• IRAs inherited from one decedent cannot be aggregated with IRAs inherited from another decedent. The IRAs from each decedent must pay their own RMDs.
• Husband and wife must each take his or her own RMD from his or her own accounts. If one spouse takes more than the RMD, that cannot be used to reduce the other spouse's RMD.

Which Asset(s) Should Be Distributed? Despite the frequent admonition in the financial press to "always keep sufficient cash in your IRA to cover the RMD," there is no requirement that RMDs be paid in cash. A distribution of assets is perfectly fine. The fair market value of the asset on the date of distribution will be included in the recipient's income to the same extent a cash distribution of the same amount would have been included. That value then becomes the recipient's basis in the asset going forward for purposes of computing gain or loss on later sale of the asset. Consider an "in-kind" distribution if the retirement plan is fully invested, with no cash component, and you have no need or desire to sell any of the assets.

Use the RMD to move assets out of the IRA that would be better off in the taxable account, such as a growth asset you would like to gift to your children, or (now that the IRS is moving toward requiring special reporting for hard-to-value assets held in IRAs) a hard-to-value asset you would like to hold outside the IRA to avoid triggering new IRS reporting requirements, or a closely held type of asset that you can foresee may lead to prohibited transaction problems if it remains in the IRA (such as a piece of raw land you have held as a passive investment but now want to develop).

Charitable Giving With the RMD Qualified charitable contributions, when permitted, allow the over-age-70-1/2 IRA owner to transfer cash directly from her IRA to a public operating charity. Unfortunately, we do not yet know whether QCDs will be permitted for 2015. The QCD Code provision has expired, but Congress has a strong history of re-enacting it very late in the year retroactive to the beginning of the year, so many expect that will also occur in 2015.

If permitted, QCDs are allowed in amounts up to $100,000 per year per IRA owner (not per IRA!). The QCD is a favorable way to make a charitable gift because the distribution satisfies the RMD requirements, yet it is not included in the IRA owner's income. This keeps the IRA owner's gross income lower than otherwise, which is beneficial for many purposes, such as reducing the impact of the reduction of itemized deductions applicable to high-income individuals under Code § 68, determining the "threshold" for applying the 3.8% tax on net investment income, calculating Medicare premiums two years later, and getting the benefit of medical expense deductions.

Unfortunately we do not yet know whether the tax law will be amended to permit QCDs this year. If the IRA owner would donate her 2015 RMD to charity regardless of whether QCDs are permitted, she might as well have the charitable donations transferred directly from her IRA to the qualifying charity (or charities) now. If Congress does not renew this law, then she will be taxed as if she received the distribution (includible in gross income) then donated it to charity (itemized deduction)--which is exactly what would happen if she took the distribution in cash then donated it to charity. If the law is extended and made retroactive, she will have its benefits.

However, there is no easy planning answer for the client who would use the QCD if it is available, but who would use other means to make charitable gifts in 2015 (such as transferring appreciated property to the charity) if QCDs are not available. These individuals have to wait until possibly the very end of the year before they can determine the best way to make their 2015 charitable gifts, watching C-SPAN and reading the Federal Register daily.

Where to read more: For full details on required minimum distributions, see Chapter 1 of Life and Death Planning for Retirement Benefits. Regarding qualified charitable distributions, see Chapter 7 of the e-book edition of Life and Death Planning for Retirement Benefits (or the free supplement to the print edition posted at https://www.ataxplan.com/).

Now available in electronic edition! By popular demand, Natalie Choate's book Life and Death Planning for Retirement Benefits has been published in an electronic version. The e-book edition gives you the entire book in word-searchable format, PLUS two additional chapters (on life insurance and annuities in retirement plans) that were left out of the print edition for reasons of space. Updates for the new 2015 rollover rules are already incorporated into the e-book. And of course the convenience you expect from an electronic format: Word-searchable text. Live links to cross-referenced book sections and most cited tax sources. Access anywhere you have an internet connection. Only $9 per month; cancellable at any time. Visit http://www.retirementbenefitsplanning.com to subscribe or learn more.