Beginning at age 72 (or 70½ if you turned 70½ on or before December 31, 20191) IRA owners are required to take annual withdrawals from their IRAs– whether they need the income or not.
Tax laws require these annual payments to ensure tax-deferred IRA assets enter the tax stream. Some investors need their IRA savings to supplement their retirement income and welcome the “paycheck” each year. But, if taking money out of your IRA each year does not fit your plans, you may want to consider some RMD strategies that satisfy the tax laws but also help you better achieve your retirement income and investment goals.
RMD Rules Refresher
The RMD rules apply to Traditional, SEP and SIMPLE IRAs. If you have multiple IRAs, you have multiple RMDs due for the year. The amount to be distributed each year is calculated by dividing your IRA’s prior-year December 31 account balance by a life expectancy factor based on your age, as set forth in IRS life expectancy tables. This calculation determines the minimum amount that must be distributed for that IRA for the year.
Your first year’s required minimum distribution (RMD) is due for the year you turn age 72. You may take your first RMD any time between January 1 of that year through April 1 of the following year. All subsequent years’ RMDs must be withdrawn by December 31 each year. If you miss taking an RMD timely, you will be subject to a 50% tax on the amount that was supposed to be withdrawn but remained in the IRA.
Build up cash reserves
Not having enough liquid investments in your IRA to satisfy the RMD each year is a challenge many self-directed IRA owners face. If you have most of your IRA assets tied up in alternative investments, you may be forced to liquidate at an inopportune time. You can plan for this in the years leading up to age 72 by making annual contributions to build up cash reserves in your IRA or liquidating certain investments at a time when it is more beneficial to you.
You may also choose to consolidate your employer plan and other IRA savings into your self-directed IRA to help create a cash reserve or increase liquid investments. Be aware, however, that if you are age 72 or older, the first distribution from a tax-qualified account each year must go toward satisfying your RMD for that account. Your RMD cannot be rolled over. Direct transfers from IRA to IRA are not subject to this requirement.
If you have multiple IRAs, one of the best strategies to protect your illiquid investments is to aggregate your RMD amounts for all of your IRAs and take the total amount due from the IRA(s) with investments that are best to liquidate at that time. Tax laws require that an RMD be calculated separately for each IRA. But once you have calculated the amount due, you may withdraw that amount from any of your IRAs, except a Roth IRA. (You also may not satisfy an IRA-required RMD from an employer plan, like a 401(k) or 403(b) plan.) Aggregating your RMDs allows you to select which investments to liquidate across your various IRAs. If you have multiple IRAs, you may want to designate at least one as having short-term, low-risk investments to cover the RMD payments each year.
Convert to Roth IRA
If you are able to manage the tax impact of including the value of an investment in your income for the year but would like to continue to defer or eliminate taxes on the investment growth, consider converting all or a portion of your IRA to a Roth IRA. Roth IRAs are not subject to the RMD rules while you are alive. This means you are not forced to take distributions from the Roth IRA each year, and you may continue accumulating IRA assets beyond age 72. If you’re older than 59½ and have had a Roth IRA for at least 5 years, all withdrawals from the Roth IRA will be tax-free, even the investment growth. Any Roth IRA assets inherited by your heirs after your death will also be tax-free (although beneficiaries are required to deplete the Roth IRA within a certain number of years).
The consideration with a Roth conversion, of course, is that you must include the pre-tax amount converted in your taxable income in the year of conversion. And you must satisfy any RMD due for the year before you convert assets to a Roth IRA.
For More Information
STRATA Trust will notify you each year you have an RMD due and will help you calculate your RMD amount. However, you are responsible for ensuring your RMD is paid out each year. You may want to talk to your tax or financial advisor to explore the RMD strategies that will best serve your immediate and future investment and retirement income objectives.
If you have any questions about RMDs, please contact us at 866-928-9394 or Service@StrataTrust.com.
1 Provisions of the SECURE Act revised the RMD age to 72 for anyone turning age 72 on or after January 1, 2020. For those persons that turned 70½ on or before December 31, 2019, your first year’s RMD is due for the year you turn age 70½ (i.e., the year that contains the date that is 6 months following your 70th birthday).