Last year, the first batch of baby boomers turned 70½, which means if you serve retirees you are likely to spend a good portion of the last quarter of each year for the rest of your career helping clients take the required minimum withdrawals called RMDs from their retirement accounts.
Technically, it’s the client’s responsibility to make sure the RMDs are met. But since blithely informing them of that fact isn’t an optimal response, here are a few things you (and the clients) should know.
Two for one?
Clients new to the arcane RMD rules are likely to be confused by the deadlines that apply to their first couple of withdrawals.
The deadline for the first RMD is April 1st of the year after the IRA owner turns 70½. But the client can still meet the deadline by taking instead the first distribution by Dec. 31 of the year he turns 70½. Retirement account owners who expect to be in the same or lower tax bracket in the year in which they turn 70½ as in the subsequent year should probably take one distribution by Dec. 31 of the year they turn 70½, and then another one by the same date the following year. On the other hand, those who may be in a lower bracket during that following year might want to take two distributions in the year after they turn 70½; the first by April 1 and the second by Dec. 31.
The cost of ignorance
Failing to take the RMD can have expensive consequences. The IRS can impose a 50 percent excise tax on whatever should have been withdrawn in a timely manner, but wasn’t. Plus, the account owner still has to take the missed RMD and pay taxes on the amount. For instance, a $10,000 missed RMD amount may net only about $3,000 or less to the IRA owner once the income and excise taxes have been applied. However, even if the clients neglect to take any RMD out by the deadline, all is not lost. It happens often enough that the IRS has a pre-established process to deal with the situation. Errant IRA owners should take the belated RMD as soon as possible. When filing their taxes for the year, they should complete Section 9 of IRS Form 5329 and throw themselves on the mercy of the IRS for forgiveness.
All from one, except ...
You may be aware that, although clients’ RMDs are based on the value of all of their non-Roth retirement accounts, the actual withdrawal doesn’t have to be taken proportionately from each separate account. Instead, the client can take the entire RMD amount from just one (or more) of the accounts. However, that tactic can only be applied to “like” accounts.
For instance, if the client has a 403b and a few individual retirement accounts, she can take all of the IRA-based RMDs from a single IRA. But she would have to make a separate calculation based on the value of the 403b account, then withdraw that amount directly from the 403b.
RMD to Roth?
One common question clients will ask is, “Can I convert my RMD amount to a Roth IRA?” The answer is “no”. However, IRA owners can convert amounts over the RMD figure to a Roth IRA. And, it may be a good idea to do so, especially if clients can do it at a low tax rate. You and/or your clients can figure the conversion’s potential tax ramifications by visiting H&R Block’s Tax Calculator and Estimator at tinyurl.com/hrbcalc.
Selling isn’t mandatory
Clients without enough cash in their retirement accounts don’t necessarily have to liquidate securities to raise the funds needed to take the RMD. Instead, they can transfer securities “in kind” to their non-retirement accounts. Once transferred, the new cost basis of the position is the value on the date the transfer is made.
This maneuver can be especially helpful if clients would be charged a commission to sell the security in the retirement account and/or buy an investment with the RMD proceeds. It’s also a good idea to perform an in-kind transfer if the retirement account owner has to sell a small fixed-income bond to raise the RMD funds and may not get an optimal bid on the security from the secondary market.
Benevolent clients can use their RMD to help a charity and cut their income taxes—even if they don’t itemize and can’t deduct the donation in the traditional sense.
Through the Qualified Charitable Deduction IRA owners over age 70½ can transfer up to $100,000 directly from their retirement accounts tax-free to one or more qualified non-profits or charities in a given year, and if the transfer meets or exceeds the RMD amount, it will satisfy the RMD requirement. Better yet, since the charitable IRA distribution won’t be added to the client’s taxable income, it may help him avoid losing out on certain low-income tax benefits or incurring taxes on his Social Security retirement benefits.
But, there are certain restrictions to this process that could easily trip up the uninformed.
First, to meet the QCD requirements the distribution has to go directly from the retirement account custodian (likely your firm) to a qualified charity. The client can’t, say, take possession of the distribution, then write a check to the charity for an equal amount. Second, as of this writing, the QCD can’t go to a donor-advised fund and still qualify, although there has been credible speculation that such a move may be allowed in the future. Finally, the transfer from the client’s retirement account to the charity has to be completed by Dec. 31 of the corresponding year.
With how hectic the schedules of clients, charities and your practice can get at the year-end, it’s best that you broach the subject of the QCD and RMDs sooner rather than later.