Now that we’re in the final quarter of the year, older taxpayers need to keep a careful eye on their required minimum distributions (RMDs) for the year, as a stiff penalty applies to those who don’t withdraw enough from their retirement accounts. This article explains the rules that apply and offers a withdrawal strategy for those affected by the stock market decline and for older taxpayers who would be interested in using the qualified charitable contribution tax break this year, should it be retroactively reinstated by Congress.
Take the RMD or pay a big penalty. Taxpayers must start taking annual RMDs from their traditional IRAs by April 1 following the year in which they attain age 70 1/2. As for qualified plans like a 401(k), 5% owners are subject to the same rules as apply for IRA owners. However, for a non-5% owner, RMDs must commence by April 1 of the year following the later of the year in which the taxpayer (a) reaches age 70 1/2, or (b) retires. (Code Sec. 401(a)(9), Code Sec. 408(a)(6)) Failure to withdraw the annual RMD could expose the taxpayer to a penalty tax equal to 50% of the excess of the amount that should have been withdrawn over the amount that actually was withdrawn. (Code Sec. 4974)
The amount of each RMD is calculated separately for each IRA. However, the RMD amounts for the separate IRAs may be totaled and the aggregated RMD amount may be paid out from any one or more of the IRA accounts. (Reg. § 1.408-8, Q&A 9)
Illustration: Jack has two separate traditional IRAs. The RMD from IRA-A is $6,000, and the RMD from IRA-B is $4,000. He may take his total $10,000 RMD from either IRA-A or IRA-B, or take distributions from both, as long as the total IRA payout for the year is $10,000.
Observation: This rule gives flexibility to owners of multiple IRAs, especially during stock market declines. For example, if an IRA is invested in stocks or mutual fund shares whose price currently is depressed, the minimum distribution can be made from a money-market IRA, or another IRA invested in a fund showing gains, to avoid selling at a market low and losing future appreciation potential.
Caution: Many financial institutions automatically place each year’s RMD in a separate non-IRA account. This procedure avoids the risk of penalties for insufficient distributions. A taxpayer who wants to take his RMD from another IRA should notify the trustees or custodians of the IRAs from which he does not want to withdraw, in order to avoid potentially having an amount be automatically withdrawn from them.
The rule permitting amounts in traditional IRAs to be aggregated for RMD purposes applies only to IRAs that an individual holds as an owner. It doesn’t apply to IRAs that an individual holds as a beneficiary. IRAs held by a person as a beneficiary of the same decedent may be aggregated, but can’t be aggregated with amounts held in IRAs that the individual holds as the IRA owner or as the beneficiary of another decedent. And no traditional IRA can be aggregated with a qualified retirement plan account or a Roth IRA to determine payouts. (Reg. § 1.408-8, Q&A 9) Additionally, RMDs must be calculated separately for each qualified plan account and paid separately. (Reg. § 1.401(a)(9)-5, Q&A 1, Q&A 3)
RMD strategy for dealing with possible revival of qualified charitable contributions. For pre-2015 distributions, an annual exclusion from gross income (not to exceed $100,000) was available for otherwise taxable IRA distributions that were qualified charitable distributions. (Code Sec. 408(D)(8)) Such distributions weren’t subject to the general percentage limitations that apply for making charitable contributions since they weren’t included in gross income and couldn’t be claimed as a deduction on the taxpayer’s return. Since a qualified charitable distribution wasn’t includible in gross income, it didn’t increase AGI for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified levels.
To constitute a qualified charitable distribution, the distribution had to be made (1) after the IRA owner attained age 70 1/2 and (2) directly by the IRA trustee to a Code Sec. 170(b)(1)(A) charitable organization (other than a Code Sec. 509(a)(3) organization or a donor advised fund (as defined in Code Sec. 4966(d)(2)). Also, to be excludible from gross income, the distribution had to be otherwise entirely deductible as a charitable contribution deduction under Code Sec. 170 without regard to the regular charitable deduction percentage limits.
Observation: There’s reason to be optimistic that the qualified charitable distribution will be revived, since it has been retroactively extended several times before. Code Sec. 408(d)(8) was first enacted by the Pension Protection Act of 2006 (P.L. 109-280). It expired on Dec. 31, 2007 but was retroactively revived and extended through 2009. After it expired on Dec. 31, 2009, it was retroactively revived and extended through 2011. After expiring on Dec. 31, 2011, Code Sec. 408(d)(8) was retroactively reinstated and extended through 2013. Late in 2014, this provision was retroactively extended for one year so that it was available for charitable IRA transfers made in tax years beginning before Jan. 1, 2015.
The qualified charitable distribution was a preferred strategy for taxpayers who didn’t need to withdraw money from their IRAs but had to do so anyway because of the RMD rules. This is because a direct distribution from an IRA to a charity was not included in the taxpayer’s gross income, but it was taken into account in determining the owner’s RMD for the year.
Recommendation: Taxpayers who would benefit this year from taking charitable contribution deductions (if they were available) instead of RMDs, should consider deferring their RMD for 2015 until near the end of the year. If the charitable contribution deduction is revived for 2015 before the end of this year, the taxpayer can have the charitable contribution counted towards his RMD. And, if that deduction isn’t revived before the end of the year, he can make a full RMD contribution before the end of the year.