IRA Required Minimum Distributions

Aug 17, 2020Business

How to Calculate RMDs

A common question we hear from our clients: Is there a way to limit the impact of required minimum distributions (RMD)?  

If you have a traditional IRA, you must take a minimum distribution from your account once you turn 72. Note: The SECURE Act became law on December 20, 2019, and increased the age from 70 ½ to 72.  

Although these distributions are required each year and generally taxable, several strategies can be used to minimize taxation of the distribution and optimize savings for the account holder.

  1. Take only the minimum amount – By taking only the required minimum distribution amount, assets remain in the IRA and continue to grow. This allows the funds to be stretched over your primary beneficiary’s life expectancy and hopefully provide more to your heirs.
  1. Distribute the RMD early in the calendar year – Year-end is busy for most. By taking your RMD early in the year, it checks this off your list of to-dos. Failure to make the RMD each year will result in a 50% penalty from the IRS and ordinary income tax.
  1. Convert your account to a Roth IRA – Unlike a traditional IRA, a Roth IRA does not require any distributions at all. This means the money can grow tax-free for as long as you want. Be aware though, doing this will mean paying taxes all at once on those funds.
  1. Distribute depreciated stock instead of cash – If you own depreciated stock in your IRA, it may be beneficial to distribute it for your RMD. Distributions from an IRA are taxed as ordinary income at a rate that could be up to 37%. However, if the stock is distributed to a non-IRA account, appreciates, and is sold after holding it for 12 months, you will pay long-term capital gain taxes. Long-term capital gain tax rates range from 15% to 20% and are generally lower than ordinary income tax rates. 

One caution with this strategy: if you hold the distributed stock outside of your IRA for less than a year before selling it, you will still pay the higher ordinary income tax rate on any gains.

  1. Consider a Qualified Charitable Distribution (QCD) – Donations of up to $100,000 per person per year are allowable as a QCD. By using your RMD as a QCD, the distribution is excluded from taxable income. If you are claiming a standard deduction on your tax return, doing a QCD is the only way to get any kind of tax benefit from your charitable donations. The QCD must be made directly from your IRA to the qualified charity. If you take a regular withdrawal from an IRA and then use it to make a charitable contribution, you still need to include that distribution in taxable income. 

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  1. Fund a life insurance policy with your RMD – If you do not need your RMD for living expenses in retirement, consider the IRA Maximization strategy. Under this strategy, you would use your RMD to pay the premiums on a life insurance policy held by an individual life insurance trust (ILIT). Upon your death, the death benefit will be paid to the ILIT for distribution to your beneficiaries without being subject to income or estate taxes.

News: Coronavirus Aid, Relief, and Economic Security (CARES) Act suspended RMDs for 2020. These strategies may not work for everyone in 2021 and moving forward; however, it is important to understand that there are options for RMDs that should be considered.

Retirement planning can be complex, requiring help from trusted professionals who understand the challenges, rewards and opportunities. For more information about the above tips or to learn about how we can help, please contact a Smith Schafer professional.

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