The end of the year is the deadline for most individuals with qualified retirement plans and IRAs to take their required minimum distributions (RMDs) if they have attained age 70½ or inherited their benefits (Code Sec. 408(a)(9)). RMDs for 2016 are based on the account’s value at the end of 2015. The failure to take RMDs can result in a 50% penalty (Code Sec. 4974). As part of its Tax Preparedness Series, the IRS reminded affected individuals to remember to take their RMDs by December 31 (IR- 2015-122, 10/29/15). Here are some key issues that can impact RMDs.
Those who Turned 70½ in 2015
Clients who were born July 1, 1945, to June 30, 1946, attained age 70½ in 2016. This means that they have attained their required beginning date for purposes of RMDs and must take their first one by December 31, 2016. However, they can opt to postpone the first RMD until April 1, 2017. Doing so means taking two RMDs in 2017 (one by April 1 and one by December 31).
For those who meet the age requirement but are still working, the first RMD with respect to qualified retirement plan benefits can be postponed until they leave employment (assuming the plan permits this action). However, this rule does not apply to anyone owning more than 5% of the company. The rule does not apply with respect to IRAs, regardless of company ownership.
The RMD rules do not apply for account owners during their lifetime.
An RMD does not have to be taken in a single withdrawal. All that is required is that the total amount withdrawn for the year at least equals the RMD amount. Withdrawals are not limited to the RMD amount; more or even all of the account can be withdrawn even though the owner has reached his or her required beginning date.
Usually, for IRAs, the trustee or custodian shows the RMD amount in Box 12b of Form 5498, IRA Contribution Information. Thus, the 2016 RMD amount should have been shown on a 2015 Form 5498, which would have been issued to the IRA owner in January 2016. For qualified retirement plans, the administrator must compute the RMD and provide this information to the participant.
In figuring RMDs, all traditional IRA accounts can be aggregated with the annual sum withdrawn from one or more of the accounts. In figuring RMDs from qualified retirement plans , no aggregation is permitted; RMDs must be figured for and taken from each plan.
Qualified Direct IRA Transfers
Under a special rule, those age 70½ or older by the end of the year can directly transfer up to $100,000 from their IRAs to a public charity, and such transfer is taxfree (Code Sec. 408(d)(8)). The transfer, called a qualified charitable donation (QCD), can include RMDs. Those who inherited an IRA can use this rule as long as they are at least age 70½ by year-end. Married persons filing jointly can exclude $100,000 each (a total of $200,000 on a joint return). No charitable contribution deduction is allowed for the transfer. This direct transfer rule does not apply to SEPIRAs, SIMPLE-IRAs, or Roth IRAs.
Tax Benefits of Qualified Direct IRA Transfer
By keeping the IRA distribution out of gross income, adjusted gross income (AGI) is minimized. This has the favorable effect of increasing eligibility to various other tax breaks based on AGI or modified AGI. For those who do not itemize, it is a way to benefit their favorite charities on a tax-advantaged basis. For all higher-income individuals, minimizing AGI in 2015 can translate into avoiding or minimizing the additional Parts B and D premiums for Medicare in 2017.
Those who recently inherited IRAs and qualified retirement benefits have decisions to make. There are actions to take that impact the taxation of inherited benefits. If the decedent died after age 70½, his or her RMD for the year must still be taken; it is taxable on the decedent’s final income tax return.
They can treat the account as their own, allowing them to postpone distributions until they are age 70½ and name their own beneficiaries. If they do not treat the account as their own, then they must take RMDs under the same rules applicable to nonspouse beneficiaries.
They cannot roll over inherited accounts to their name as can surviving spouses. The account must be retitled property to reflect the decedent’s name, date of death, and the beneficiary’s name with the beneficiary designation. However, nonspouse beneficiaries can roll over inherited accounts (e.g., change brokerage firms for an IRA) as long as the accounts are registered properly.
No RMDs usually are required in the year of the decedent’s death. Beneficiaries must begin their RMDs by December 31 of the year following the year of death (e.g., December 31, 2016, for a decedent dying in 2015). Here are the payout options:
• Begin RMDs based on the beneficiary’s life expectancy. Life expectancy is found in IRS Publication 590-B, Appendix B, Table I (Single Life Expectancy). However, if the decedent died on or after attaining age 70 ½, RMDs are based on the longer of the beneficiary’s life expectancy (from the Single Life Expectancy table) or the decedent’s life expectancy (usually Table III (Uniform Lifetime). This rule is helpful in minimizing distributions to a beneficiary who is older than the decedent.
• Delay distributions but withdraw the entire account by the end of the fifth year following the year of the owner’s death.
Beneficiaries under age 59½ taking distributions from IRAs and qualified retirement plans are not subject to the 10% early distribution penalty (Code Sec. 72(t)(2)(A)(ii)).
While distributions from Roth IRAs are not taxable, inherited accounts are subject to the same distribution rules as those applied to IRAs and qualified retirement plans.
RMDs, other than for Roth IRAs and other accounts in which there is basis (the owner made after-tax contributions), taxable income results. Federal income tax is automatically withheld from distributions. A 10% withholding rate applies to nonperiodic distributions (e.g., RMDs) unless the taxpayer wants no withholding. If the 10% withholding is not sufficient to meet projected tax liability, the client can ask that an additional amount be withheld. Form W-4P, Withholding Certificate for Pension and Annuity Payments, is used to opt out of withholding or request additional withholding. Alternatively, the client can pay estimated taxes for projected tax liability on RMDs.
Those who must take RMDs for 2016 should determine their necessary withdrawals. Clients should also decide now how to receive their distributions (e.g., by check, transfers to taxable accounts), and advise plan administrators, custodians, and trustees accordingly.
Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is counsel at Kostelanetz & Fink, senior consultant to Citrin Cooperman & Company in New York City and is consulting editor to CCH.