An important IRA deadline for retirees is approaching
As 2017 starts drawing near its end, many retirees with IRAs face a deadline that’s easy to overlook — but can be costly if you do. If you’re 70½ and have a balance in an IRA, you must take the so-called required minimum distribution (RMD). If you don’t take your RMD, you could face a stiff penalty.
There’s one exception to this rule, and it’s for anyone who turned 70 this year. In that case, you can delay taking the first RMD until April 1 of the year following the year you turn 70½ . But it’s often not wise to wait until the April deadline. If you do, you’ll also have to take the RMD for 2019 in the same year, meaning you’re on the hook for two RMDs — the one you delayed from 2018 and one for 2019. Two RMDs in the same year could bump you into a higher tax bracket and increase what you owe Uncle Sam.
You’ll want to make sure to take the required amount and not a penny less. Underwithdrawing can cost you. If you don’t withdraw enough or fail to make your withdrawal on time, the IRS can levy a penalty of up to 50 percent of the difference between the amount you actually withdrew and the amount you should have taken out.
The minimum amount you must withdraw is specified in IRS Publication 590-B, which lists the factor to use, based on your age, for calculating the amount you must withdraw.
A loophole for workplace retirement plans
If you’re over age 70½ and are still working, you’re also subject to the RMD rules. However, you can put off distributions from your employer’s retirement plans, such as a 401(k), while you’re working. You can wait to start withdrawals from that plan until the later of April 1 following the year in which you reach age 70½ or the year you actually retire. So if you remain working for an employer, even part-time, you don’t have to take an RMD from that employer’s retirement plan until after you retire.
This special rule doesn’t apply to an IRA, and after-tax Roth IRAs are not subject to RMDs.
Some advisers recommend that you sell shares of stocks, bonds or mutual funds by now if you face an RMD trigger. That way you’ll be sure the proceeds from the sale will be available as cash that you can then use to make the RMD. This advice seems to imply (and most people think it does) that RMDs must be made in cash.
But that’s not the case. You can actually take distributions from your IRA for any reason, not just RMDs, either in cash or “in kind.” This means you can distribute the actual shares of stock or mutual funds from an IRA and use them to satisfy your RMD.
What to know about “in-kind” distributions
The advantages of using an in-kind distribution of shares is that it allows you to keep the amount of the distribution fully invested. If a specific stock’s price is down or you believe it’s undervalued, you might want to hold onto the shares and distribute them, instead of selling them to take a cash withdrawal.
Of course, the market value of the shares on the date they were distributed from the IRA would be taxed as ordinary income (the same as for cash distributions). But any gain on the shares after the date of distribution would be taxed at capital gains tax rates.
Another advantage of taking an in-kind distribution is that you don’t have to sell the position in your IRA and then buy it back in another account with the distributed cash. Avoiding these round-trip transactions will save a trade commission for each trade. In the case of shares of a mutual fund that charges a front-end load or a redemption fee, you’ll avoid those charges as well when you take an in-kind distribution.
Finally, if the mutual fund you own is closed to new investors, you may want to distribute the shares in-kind, instead of selling them in the IRA to raise cash for the RMD.
The downside of taking in-kind distributions is that if the position involved typically experiences significant price swings, you’ll have to distribute a few extra shares to ensure that their value at the time of the distribution was sufficient to meet the RMD amount.
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