April 1 Deadline Looms For IRA Holders

By Ashlea Ebeling

Congress’ one-year suspension of required minimum distributions for Individual Retirement Accounts in 2009 is still causing confusion two years later. Because of the way the RMD holiday played out for folks due to take money out of their IRAs for the first time, there was no April 1 deadline for IRA holders last year, but there is this year.

“It’s confusing in any year,” says Ken Hevert, vice president, personal retirement products with Fidelity Investments. But this year, there’s a series of things compounding the typical confusion over the perplexing IRA rules, he says. That is, namely, the suspension of RMDs in 2009, followed by the return of RMDs last year, and the different deadlines for those new to RMDs in 2009 and 2010. On top of all that is this: “Many of these individuals have been in a savings mindset for 30-plus years, and now they have to reverse that mindset,” Hevert says.

Here’s the lowdown. IRA owners must normally begin taking annual RMDs after they turn 70 and a half from their own traditional IRAs or IRAs inherited from a spouse, although not from their Roth accounts. Non-spousal IRA heirs of any age must take RMDs from both traditional and Roth accounts. If you don’t take an RMD, you’re subject to a penalty equal to 50% of the missed payout. (For how the IRS is cracking down on IRA mistakes, including missed payouts, click here.)

Typically IRA owners who are required to take RMDs have until Dec. 31 of that tax year to take the money out. (The amount you must take out is calculated based on your life expectancy and the balance in your IRAs the end of the prior year.) But for folks who turn 70 and a half, they typically have until April 1 of the following year to take their first distribution.

That means that for folks who turned 70 and a half last year (those born July 1, 1939 to June 30, 1940), they have until April 1, 2011 to take required minimum distributions for 2010. According to Fidelity, 12% or 61,000 of their 500,000 IRA customers turned 70 and a half last year, but almost four out of ten (39%) of them hadn’t taken their 2010 distributions as of year-end 2010. Granted, some of them might be taking the withdrawals from IRAs held at other custodians, but many just likely haven’t gotten around to taking the money out yet, says Hevert.

The folks who waited until this year to take their first RMDs will have to take two RMDs in this calendar year (one by April 1 to count for the 2010 distribution, and the other by Dec. 31 to count for 2011), possibly putting them in a higher marginal tax bracket.

“People wait ‘til the last minute, but that can cost them,” says Seymour Goldberg, a Woodbury, N.Y. lawyer and IRA expert. Besides the tax bracket problem, folks in states with retiree tax breaks might lose out on a year of substantial tax savings. New York, for example, gives seniors a $20,000 annual exemption from state income taxes for pension income, including IRA distributions, Goldberg notes.

Part of the confusion this year is that the rules were different for folks who turned 70 and a half in 2009. They got to take advantage of the RMD holiday, so there was no April 1 deadline in 2010. Instead, those folks had until Dec. 31, 2010 to take out their first annual distribution (which would have been their second had there been no reprieve). This year they have to take out their 2011 distribution by Dec. 31, 2011.

For folks turning 70 and a half this year, they have the normal option of taking their 2011 distribution this year or deferring until April 1, 2012. If you don’t need to take the money out for immediate spending needs, you should time the distributions carefully.

Yet another big mistake, Goldberg points out, is that people don’t know that there is an RMD required in the year of death, if the deceased is over 70 and a half. Families roll over the whole IRA by mistake, but the RMD should first be distributed out to the beneficiaries named on the IRA beneficiary designation form (not the estate), he says.

A sensible proposal in Obama’s 2012 budget would eliminate RMDs for individuals whose tax-favored retirement accounts (including Roth IRAs) totaled less than $50,000. For more on this proposal, click here.

How about getting rid of the 70 and a half nonsense, and the April 1 date? Here’s my tax reform proposal: The year you turn 70, you take a withdrawal by year-end.