A critical date is approaching for many clients who attained age 70 1/2 in 2010. By Apr. 1, 2011, these clients must commence making required minimum distributions (RMDs) from their regular IRAs. (Lifetime distributions need not be taken from Roth IRAs at any age.) (Code Sec. 408A(c)(5)) A participant in a qualified retirement plan (e.g., 401(k) plan) must begin taking distributions by Apr. 1 of the calendar year following the later of the year in which he: (a) reaches age 70 1/2, or (b) retires (except for 5% owners, who are subject to the same rules as IRA owners). But a qualified plan may provide that the required beginning date for all employees (including non-5% owners) is Apr. 1 of the calendar year following the calendar year in which the employee attains age 70 1/2. (Code Sec. 401(a)(9)(C); Reg. §1.401(a)(9)-2, Q&A 2(e))
How to find RMD. If the IRA account balance is not distributed in full to its owner by the required beginning date, the RMD for each year from IRAs or individual accounts under a qualified defined contribution plan is found by dividing the account balance as of the end of the preceding year by the life expectancy factor from a uniform table in Reg. §1.401(a)(9)-9, Q&A 2. This table is used in all cases, except where the account's designated beneficiary is the account owner's spouse and is more than 10 years younger than the owner. Where the spouse is more than 10 years younger than the owner, the joint life and last survivor life expectancy table in Reg. §1.401(a)(9)-9 Q&A 3 is used. (Reg. §1.401(a)(9)-5, Q&A 4(a))
Caution: The Apr. 1 required beginning date (RBD) is critical because failure to begin required minimum distributions (RMDs) could expose the taxpayer to a penalty tax equal to 50% of the difference between the amount that should have been withdrawn and the amount that was withdrawn. (Code Sec. 4974) However, the penalty may be waived if the shortfall in the distribution was due to reasonable error, and reasonable steps are being taken to remedy it.
Effect of QCDs. Under Code Sec. 408(d)(8), an individual who is age 70 1/2 or older may exclude from gross income up to $100,000 that is paid from his IRA to a charitable organization in any tax year after Dec. 31, 2005, and before Jan. 1, 2012. Such qualified charitable distributions (QCDs) originally didn't apply to distributions made after Dec. 31, 2009, but were extended through 2011 by the 2010 Tax Relief Act, which also provided individuals with the option of treating a QCD made in January of 2011 as made in 2010 for tax purposes. The excluded amount can be used to satisfy any RMDs that the IRA owner must otherwise receive from his IRA for 2010 and 2011.
A QCD made by Jan. 31, 2011 will satisfy the IRA owner's RMD for 2010. So, if an IRA owner had not taken his 2010 RMD by Dec. 31, 2010, a QCD made in January of 2011 that he elects to treat as being made in 2010 will count towards his 2010 RMD. Then, to calculate the amount of the IRA owner's RMD for 2011, subtract the full amount of the 2010 QCD made in January of 2011 from the total of his IRA account balance(s) as of Dec. 31, 2010.
Observation: As a result of subtracting the full amount of the 2010 QCD made in January of 2011 from the total IRA account balance(s) as of Dec. 31, 2010, the RMD for 2011 will be reduced. This is because RMDs are computed based on the value of the account at the end of previous year.
Attainment of age 70 1/2. A taxpayer attains age 70 1/2 as of the date that is six months after the 70th anniversary of his birth.
Observation: A taxpayer attained age 70 1/2 in 2010 if he was born after June 30,’39, and before July 1,’40.
Multiple IRAs. If your client has several traditional IRAs or qualified plan accounts, the amount of each RMD is calculated separately for each IRA. However, the RMD amounts for the separate IRAs may be totaled and the aggregated RMD amount may be paid out from any one or more of the IRA accounts. (Reg. §1.408-8, Q&A 9) Roth IRAs aren't included.
Illustration: Jack has two separate IRAs. The RMD from IRA-A is $8,000 and the RMD from IRA-B is $4,000. Jack may take his total $12,000 RMD from either IRA-A or IRA-B, or take distributions from both as long as the total IRA payout for the year is $12,000.
Observation: This rule provides flexibility to owners of multiple IRAs. For example, if an IRA is invested in stocks or mutual funds shares whose price is temporarily depressed, and another IRA is invested in bonds that haven't suffered declines, the RMD can be made from the bond-holding IRS in order to avoid selling at a market low.
Caution: Many financial institutions automatically place each year's IRA-RMD in a separate non-IRA account. This procedure avoids the risk of penalties for insufficient distributions. A taxpayer who wants to take his RMD from another IRA should notify the trustees of the IRAs from which he does not want to withdraw, otherwise, an amount might automatically be withdrawn from his IRA.
Multiple qualified plans. The amount of each RMD must be calculated and paid separately for each qualified plan. Therefore, the RMD for one qualified plan account cannot be aggregated with the RMD from another plan and distributed from one plan. If an employee's interest in a plan is divided into separate accounts, however, they generally are aggregated for RMD purposes. Note that under Reg. §1.401(a)(9)-8, Q&A 2, separate accounts in a qualified plan aren't aggregated in certain situations after the death of the account owner.
Tax planning for clients who attain age 70 1/2 in 2011. In general, the first distribution year is the year in which the IRA or qualified plan account owner attains age 70 1/2. (Reg. §1.401(a)(9)-5, Q&A 1(b)) The taxpayer may postpone the first RMD until the second distribution year (i.e., make the first RMD by Apr. 1 of the second year). But those who do that still must take a distribution for the second distribution year, resulting in two distributions in a single year. Clients attaining age 70 1/2 in 2011 should consider taking their first year's RMD during 2011, rather than waiting until 2012. Doing so may avoid a “bunching” problem in 2012.
Illustration: Angela attains age 70 1/2 in 2011 and her aggregated RMD for all her IRAs for that year is $35,000. For simplicity, assume her aggregated IRA-RMD for 2012 also will be $35,000. If Angela waits until March of 2012 to take the $35,000 RMD for her first distribution year (2011), she will have to withdraw another $35,000 from her IRAs by the end of 2012. Both amounts will be included on her 2012 return and could cause loss of tax breaks.
Consequences of delay. Delaying taking the first year's RMD until the second distribution year could have one or more of the following effects:
1. All or part of the first distribution may be taxed at a higher rate than it would have been taxed at if distributed in the first year.
Observation: Taxpayers may have an additional tax incentive—namely state tax savings—for not waiting until the second distribution year to take their first year's RMD. By waiting, they could lose the benefits of a state pension/retirement income exclusion for the first distribution year. For example, taxpayers in Delaware who are age 60 or over may claim an annual exemption of $12,500 (both husband and wife are entitled to this exemption on a joint return) for “eligible retirement income” (which includes IRA distributions).
2. It could cause some or all of the taxpayer's qualified dividends and/or net capital gains to be taxed at 15% rather than 0%.
3. More of the account owner's social security benefits may be subject to tax.
4. The resulting increase in the account owner's adjusted gross income (AGI) for the second distribution year may cause a reduction in deductions and/or credits subject to an AGI floor, such as the deduction for medical expenses and the deduction for casualty losses.
When it may be advisable to delay taking the first distribution until the second distribution year. In some situations it may be advisable for the IRA or qualified plan account owner to delay taking the first distribution from a traditional IRA or qualified plan account until the second distribution year. Here are some key examples:
... The account owner expects to be in a lower tax bracket in the second distribution year. This could result from his having lower taxable income from other sources in the second tax year, or from a reduction in the tax rate that goes into effect in the second distribution year.
... The account owner expects that taking two distributions in the same year won't cause any part of the total distribution to be taxed at a higher rate than it would be taxed at if the distributions were taken in separate years. By deferring the first distribution to the second distribution year, the distributee can continue to earn tax-deferred income on the first distribution for up to an additional three months.
... If the account owner expects to have less income from other sources in the second distribution year, deferring the first distribution to that year may enable him to avoid or minimize AGI limitations in the first distribution year without causing any increase in those limitations in the second distribution year. For example, suppose an IRA owner continues to work until after age 70 1/2 and has unreimbursed business expenses in the year he retires. By delaying taking the first distribution until the second distribution year, AGI for the year of retirement will be reduced, and more of the unreimbursed business expenses may be deductible as a miscellaneous itemized deduction.