Showing posts with label RMDs. Show all posts

Mid-Year Steps to Save on Your Taxes (Fidelity)

Key takeaways

✔ Evaluate the tax impact of life changes such as a raise, a new job, marriage, divorce, a new baby, or a child going to college or leaving home.

✔ Check your withholding on your paycheck and estimated tax payments to avoid paying too much or too little.

✔ See if you can contribute more to your 401(k) or 403(b). It is one of the most effective ways to lower your current-year taxable income.

In the midst of your summer fun, taking time for a midyear tax checkup could yield rewards long after your vacation photos are buried deep in your Facebook feed.

Personal and financial events, such as getting married, sending a child off to college, or retiring, happen throughout the year and can have a big impact on your taxes. If you wait until the end of the year or next spring to factor those changes into your tax planning, it might be too late.

“Midyear is the perfect time to make sure you’re maximizing any potential tax benefit and reducing any additional tax liability that result from changes in your life,” says Gil Charney, director of the Tax Institute at H&R Block.

Here are 9 questions to answer to help you be prepared for any potential impacts on your tax return.

1. Did you get a raise or are you expecting one?

The amount of tax withheld from your paycheck should increase automatically along with your higher income. But if you’re working two jobs, have significant outside income (from investments or self-employment), or you and your spouse file a joint tax return, the raise could push you into a higher tax bracket that may not be accounted for in the Form W-4 on file with your employer. Even if you aren’t getting a raise, ensuring that your withholding lines up closely with your anticipated tax liability is smart tax planning. Use the IRS Withholding Calculator; then, if necessary, tell your employer you’d like to adjust your W-4.

Another thing to consider is using some of the additional income from your raise to increase your contribution to a 401(k) or similar qualified retirement plan. That way, you’re reducing your taxable income and saving more for retirement at the same time.

2. Is your income approaching the net investment income tax threshold?

If you’re a relatively high earner, check to see if you’re on track to surpass the net investment income tax (NIIT) threshold. The NIIT, often called the Medicare surtax, is a 3.8% levy on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for couples filing jointly, and $125,000 for spouses filing separately. In addition, taxpayers with earned income above these thresholds will owe another 0.9% in Medicare tax on top of the normal 2.9% that’s deducted from their paycheck.

If you think you might exceed the Medicare surtax threshold for 2017, you could consider strategies to defer earned income or shift some of your income-generating investments to tax-advantaged retirement accounts. These are smart strategies for taxpayers at almost every income level, but their tax-saving impact is even greater for those subject to the Medicare surtax.

3. Did you change jobs?

If you plan to open a rollover IRA with money from a former employer’s 401(k) or similar plan, or to transfer the money to a new employer’s plan, be careful how you handle the transaction. If you have the money paid directly to you, 20% will be withheld for taxes and, if you don’t deposit the money in the new plan or an IRA within 60 days, you may owe tax on the withdrawal, plus a 10% penalty if you’re under age 55.

4. Do you have a newborn or a child no longer living at home?

It’s time to plan ahead for the impact of claiming one more or less dependent on your tax return.

Consider adjusting your tax withholding if you have a newborn or if you adopt a child. With all the expenses associated with having a child, you don’t want to be giving the IRS more of your paycheck than you need to.

If your child is a full-time college student, you can generally continue to claim him or her as a dependent—and take the dependent exemption ($4,050 in 2017)—until your student turns 25. If your child isn’t a full-time student, you lose the deduction in the year he or she turns 19. Midyear is a good time to review your tax withholding accordingly.

5. Do you have a child starting college?

College tuition can be eye-popping, but at least you might have an opportunity for a tax break. There are several possibilities, including, if you qualify, the American Opportunity Tax Credit (AOTC). The AOTC can be worth up to $2,500 per undergraduate every year for four years. Different college-related credits and deductions have different rules, so it pays to look into which will work best for you.

Regardless of which tax break you use, here’s a critical consideration before you write that first tuition check: You can’t use the same qualified college expenses to calculate both your tax-free withdrawal from a 529 college savings plan and a federal tax break. In other words, if you pay the entire college bill with an untaxed 529 plan withdrawal, you probably won’t be eligible for a college tax credit or deduction.

6. Is your marital status changing?

Whether you’re getting married or divorced, the tax consequences can be significant. In the case of a marriage, you might be able to save on taxes by filing jointly. If that’s your intention, you should reevaluate your tax withholding rate on Form W-4, as previously described.

Getting divorced, on the other hand, may increase your tax liability as a single taxpayer. Again, revisiting your Form W-4 is in order, so you don’t end up with a big tax surprise in April. Also keep in mind that alimony you pay is a deduction, while alimony you receive is treated as income.

7. Are you saving as much as you can in tax-advantaged accounts?

OK, this isn’t a life-event question, but it can have a big tax impact. Contributing to a qualified retirement plan is one of the most effective ways to lower your current-year taxable income, and the sooner you bump up your contributions, the more tax savings you can accumulate. For 2017, you can contribute up to $18,000 to your 401(k) or 403(b). If you’re age 50 or older, you can make a “catch-up” contribution of as much as $6,000, for a maximum total contribution of $24,000. Self-employed individuals with a simplified employee pension (SEP) plan can contribute up to 25% of their compensation, to a maximum of $54,000 for 2017.

This year’s IRA contribution limits, for both traditional and Roth IRAs, are $5,500 per qualified taxpayer under age 50 and $6,500 for those age 50 and older. Traditional and Roth IRAs both have advantages, but keep in mind that only traditional IRA contributions can reduce your taxable income in the current year.

8. Are your taxable investments doing well?

If your investments are doing well and you have realized gains, now’s the time to start thinking about strategies that might help you reduce your tax liability. Tax-loss harvesting—timing the sale of losing investments to cancel out some of the tax liability from any realized gains—can be an effective strategy. The closer you get to the end of the year, the less time you’ll have to determine which investments you might want to sell, and to research where you might reinvest the cash to keep your portfolio in balance.

9. Are you getting ready to retire or reaching age 70½?

If you’re planning to retire this year, the retirement accounts you tap first and how much you withdraw can have a major impact on your taxes as well as how long your savings will last. A midyear tax checkup is a good time to start thinking about a tax-smart retirement income plan.

If you’ll be age 70½ this year, don’t forget that you may need to start taking a required minimum distribution (RMD) from your tax-deferred retirement accounts, although there are some exceptions. You generally have until April 1 of next year to take your first RMD, but, after that, the annual distribution must happen by December 31 if you want to avoid a steep penalty. So if you decide to wait to take your first RMD until next year, be aware that you’ll be paying tax on two annual distributions when you file your 2018 return.

No significant changes in your life situation or income?

Midyear is still a good time to think about taxes. You might look into ways you can save more toward retirement, gift money to your children and grandchildren to remove it from your estate, or manage your charitable giving to increase its tax benefits and value to beneficiaries. A little tax planning now can save a lot of headaches in April—and maybe for years to come.

Tax-smart investing: What order to take funds out in retirement? (Fidelity)

Keys takeaways

✔ Understand the difference between taxable, tax-deferred, and tax-exempt accounts.

✔ Know which accounts to tap—and when—to maximize tax efficiency.

Chances are you contributed to a 401(k) or IRA as you saved for retirement. Now the time has come to use that money. Withdrawing from retirement savings accounts with an eye toward reducing taxes is important. Taxes can reduce income, and diminish potential future earnings and growth, which affects how long savings may last.

"The important thing to keep in mind is that managing withdrawals with taxes in mind can help boost income in retirement," explains Ken Hevert, senior vice president of retirement at Fidelity.

Let’s start by reviewing the types of investment accounts and then some tax-efficient ways to withdraw from them. Of course, everyone’s situation is unique, so it is important to consult a tax professional.

Three types of investment accounts

A typical retiree may have three types of accounts—taxable, tax-deferred, and tax-exempt. Each has an important, but different, role to play in helping manage tax exposure in retirement.

Taxable accounts like bank and brokerage accounts. Any earnings from these accounts, including interest, dividends, and realized capital gains, are generally taxed in the year they’re generated. In the case of capital gains, keep in mind that any increase in value of the accounts’ investments, such as mutual fund shares or an individual stock, isn’t a taxable event in itself. It’s only when an appreciated investment is sold that the gain is realized; i.e., it generates a taxable capital gain or loss. When you own a mutual fund, however, capital gains may be realized by the fund manager and distributed to you—often subjecting you to a tax liability—even if you haven’t sold your fund shares.
Tax-deferred accounts like traditional IRAs, 401(k)s, 403(b)s, or SEP IRAs. Most, or all, of contributions to these accounts were likely made "pretax." That means ordinary income tax on those contributions are owed when withdrawals are made in retirement. Any earnings from these accounts are also typically taxed as ordinary income when they’re withdrawn.
Tax-exempt accounts like Roth IRAs, Roth 401(k)s, and Roth 403(b)s. Contributions to these accounts are typically made with after-tax money. That means the contributions—and any earnings—are not taxable provided certain conditions are met.1

Manage withdrawals to help reduce taxes

The aim is to manage withdrawals to help reduce taxes, thereby maximizing the ability of remaining investments to grow tax efficiently.

The simplest, most basic withdrawal strategy is to use money from savings and retirement accounts in the order below, with one important caveat. For certain retirement accounts, if you are 70½ or older, required minimum distributions (RMDs) come first. For inherited qualified accounts like a traditional IRA, RMDs may come before age 70½, but the rules are complex, so be sure to check with a tax professional.

1.	Taxable accounts (brokerage accounts)

Money in taxable accounts is typically the least tax efficient of the three types. That’s why it usually makes sense to draw down the money in those accounts first, allowing qualified retirement accounts to potentially continue generating tax-deferred or tax-exempt earnings.

Investments may need to be sold when taking a withdrawal. Any growth, or appreciation, of the investment may be subject to capital gains tax. If you’ve held the investment for longer than a year, you’ll generally be taxed at long-term capital gains rates, which currently range from 0% to 20%, depending on your tax bracket (a 3.8% Medicare tax may also apply for high-income earners). Long-term capital gains rates are significantly lower than ordinary income tax rates, which in 2017 range from 10.0% to 39.6%. These are federal taxes; be aware that states may also impose taxes on your investments. (See your federal tax rate.) If you have a loss, you can use it to reduce up to $3,000 of your taxable income, or to offset any realized capital gains. Read Viewpoints "Five steps to help manage taxes on investment gains."

2.	Tax-deferred, such as traditional IRAs, 401(k)s, 403(b)s, and SEP IRAs.

You’ll have to pay ordinary income taxes when you withdraw pretax contributions and earnings from a tax-deferred retirement account, but at least these investments have had extra time to grow by taking withdrawals from a taxable account first. You may find yourself in a lower income tax bracket as you get older, so the total tax on your withdrawals could be less. On the other hand, if your withdrawals bump you into a higher tax bracket, you might want to consider taking withdrawals from tax-exempt accounts first. This can be complex, and it may be a good idea to consult a tax professional.

And remember, the IRS generally requires you to begin taking RMDs the year you turn 70½. For employer-sponsored accounts, like a traditional 401(k), you may be eligible to delay taking RMDs if you’re still working at the company and do not own 5% or more of the company or business. You cannot, however, delay starting RMDs for retirement accounts for employers you no longer work for. Read Viewpoints "Smart strategies for required distributions."

3.	Tax-exempt, such as Roth IRAs, Roth 401(k)s, and Roth 403(b)s.

Last in line for withdrawals is money in tax-exempt accounts. The longer these savings are untouched, the longer the potential for them to generate tax-free earnings. And withdrawals from these accounts generally won’t be subject to ordinary income tax. They’re totally tax free, as long as certain conditions are met.1

And leaving any Roth accounts untouched for as long as possible may have other significant benefits. For example, money for a large unexpected bill can be withdrawn from a Roth account to pay for a bill without triggering a tax liability (as long as certain conditions are met1). Qualified Roth withdrawals are not factored into adjusted gross income (AGI) because they are not taxable income. This may help reduce taxes on Social Security and other income because they don't bump up taxable income.

For Roth IRAs, it is important to note that RMDs are not required during the lifetime of the original owner, but for Roth 401(k)s and Roth 403(b)s, the original owners do have to take RMDs. That can be a good reason to consider rolling Roth 401(k)s and 403(b) accounts into Roth IRAs. Roth accounts can be effective estate-planning vehicles for those who wish to leave assets to their heirs. Any heirs who inherit them generally won’t owe federal income taxes on their distributions. On the other hand, Roth accounts are generally not an advantageous vehicle for charitable giving, so those involved in legacy planning may want to avoid the use of Roth accounts to the extent that this money is intended for charity. Be sure to consult an estate planner in either case.

Creating a plan

While the traditional withdrawal hierarchy of taxable, tax-deferred, and tax-exempt assets is a good starting point for many retirees, a person's situation and changing circumstances may mean making adjustments. That’s why it is important to have an overall retirement income plan and regularly revisit it and update it when necessary.

Suppose, for example, that a person's tax rate will be higher later in retirement than in the first few years. For instance, they move from a low-tax state to a high-tax state. If so, they might want to consider strategies where they pay taxes on their retirement savings earlier in retirement in order to potentially lower taxable income later. One way to do that, depending on a person's situation, would be to shift more of savings to a Roth IRA by converting a portion of a traditional IRA. Learn more about this in Viewpoints “Four tax-efficient strategies in retirement.”

Those who have a significant portion of investments in taxable accounts may be looking for ways to lower a tax bill on the earnings as they gradually draw down the principal to cover retirement living expenses. One consideration that might help is to invest the bond portion of taxable accounts in a diversified mix of municipal bonds, the earnings from which are generally exempt from federal income tax.

Another situation that many retirees experience when they begin withdrawing money from their traditional IRA or 401(k) is that the amount pushes them into a higher tax bracket. In that case, it might make sense to consider withdrawing from a tax-deferred account until taxable income nears the top of a tax bracket, and then tapping a Roth or other tax-exempt account for any additional income.

Those age 70½ or older might also consider making a qualified charitable distribution (QCD) to satisfy all, a portion of, or even an amount greater than an RMD—up to the IRS limits ($100,000 in 2017). Because the amount donated directly from an IRA to a qualified charity isn’t considered taxable income, this move can help avoid being pushed into a higher tax bracket. It can also be a very useful strategy for those whose high incomes result in phaseouts of itemized deductions. Be sure to consult a tax professional in such cases.

Other factors that could play a significant role in a retirement tax strategy are whether a person intends to continue working, the income tax rate in the state and locality where they plan to retire, and how much of an inheritance they would like to leave for family members or to a charity.

Know your situation

The keys to managing withdrawals from retirement accounts is to know your situation and tax exposure, to understand the basics of smart tax planning, and to consult a trusted professional to get the help you need in designing a tax-efficient retirement income plan.

You work long and hard to build retirement savings; smart tax planning can help keep your savings working for you.

Don't Make Costly Mistakes with your Required Minimum Withdrawals (Ed Slott in Financial Planning)

Costly RMD aggregation mistakes

When it comes to taking required minimum distributions, the source matters.

Many clients have more than one retirement plan or account. When they reach age 70½ and have to start taking RMDs from their own, non-inherited accounts, the question arises as to which of these distributions can be combined and taken from just one plan.

Advisers and clients may think it doesn't matter which account makes the distribution, as long as the total calculated amount is taken from one of the accounts. They are wrong. There are specific rules for aggregating RMDs.

IRS rules state that an RMD should be calculated for each account separately. Then, where aggregation is allowed, those RMD amounts can be added together and the distribution can be taken in any proportion from one or more of the aggregated accounts.

It’s also important to remember that an RMD cannot be rolled over from any one account to another account, and the RMD is considered to be the first funds distributed from any retirement account during the year.

Thus, an IRA CD that comes due in March cannot be moved in its entirety as a 60-day rollover to another retirement account. The RMD amount must be subtracted from the amount that is subsequently rolled over.

The same is true when a distribution is made from an employer plan. All plan distributions are considered rollovers, even when they go directly from the plan to another retirement account.

Advisers must make sure the RMD is taken by clients. The new IRA custodian will not have any records of the RMD calculation, and will not have any automatic reminders for notifying anyone about the RMD in the year of the transfer.IRA RMDs can, however, be transferred from one account to another. A transfer is when the IRA funds go directly from one financial institution to another. The RMD can then be taken later in the year.

RMDs for one type of account can never be taken from a different type of account. For example, a 401(k) RMD cannot be taken from an IRA, and an IRA RMD cannot be taken from a 403(b). This is a very common mistake and must always be avoided.

IRA RULES
One of the benefits of IRAs is that RMDs for multiple IRA accounts can be aggregated. This includes SEP and SIMPLE IRA accounts. The RMD should be calculated for each account separately, but after that, the RMD amounts can then be added together and taken from any one or combination of accounts.

403(b) ACCOUNTS
A similar aggregation rule exists for 403(b) accounts. A client with more than one 403(b) account can calculate the RMD for each account and then add the RMDs together. The total can then be taken from one or a combination of 403(b) accounts.

EMPLOYER PLANS
RMDs from employer plans, not including 403(b) plans and SEP and SIMPLE IRAs, cannot be aggregated. A client with multiple 401(k), governmental 457(b) or other employer plans must calculate the RMD for each individual plan and take that RMD from that plan only.

There is no need to worry about whether or not Roth IRA RMDs can be consolidated, because Roth IRAs have no RMDs during the account owner’s life time. It can’t get much simpler than that.

Any plan making a series of substantially equal payments over a period of 10 years or more, or over life expectancy, cannot aggregate that payment with the RMDs from any other retirement account. The distribution from the account making these substantially equal payments is considered the RMD from that account only.

A PRACTICAL EXAMPLE:
Your client is approaching age 70½. He comes into your office to discuss his upcoming RMDs. Just as you asked him to, he brings in a list of all his retirement accounts. He has two old 401(k) accounts, an old Keogh account, three 403(b) accounts, four IRA accounts, a SEP IRA and two Roth IRA accounts. His plan is to add together all his RMD amounts and systematically take those distributions from his smallest accounts first.

Sounds like a great plan, right? Well, let’s take a look.

First things first – when you’re trying to figure out how many accounts a client needs to take an RMD from, you must first know how many different accounts you’re dealing with. In this case, we have 13 accounts.

Next, determine what type of accounts they are and how many there are of each type, keeping owned and inherited accounts separate. Make sure you have this information correct, because getting it wrong and missing a required distribution could subject your client to a 50% penalty for any missed RMDs.

Once you’ve got your information in order, you can start anywhere.

First of all, the client has two old 401(k) accounts. The RMD for each employer’s account must be calculated. Then he must take at least the total RMD amount for each 401(k) plan from that employer’s plan. He has two RMD distributions he must take, one from each 401(k) plan. These 401(k) RMDs cannot be combined with each other or with any other RMD distribution that he must take for the year.

There is one old Keogh account. The RMD for the Keogh account must be calculated and taken from there. It cannot be combined with any other RMD distribution for the year.

Next, the client has three 403(b) accounts. He must still calculate the RMD for each of the 403(b) accounts. But he can then add these together and take his total 403(b) RMD from any one or combination of the 403(b) accounts. The 403(b) RMDs must be taken from a 403(b) account.

He also has four IRA accounts at four different IRA custodians. He has a letter from each of them detailing what the RMD should be for each account. You should double check their computations. Your client can add these four RMDs together and take the total IRA RMD from any one or a combination of IRA accounts.

In addition to the four IRAs, the client has a SEP IRA. While a SEP IRA is considered an employer plan, it is also considered an IRA for RMD purposes. The client can calculate the SEP RMD and add it to the RMD amounts for his IRA accounts. The SEP IRA RMD can be taken from either the SEP account or any of the client’s other IRA accounts, but it cannot be taken from any other type of retirement account.

Remember how the client wanted to take only one RMD distribution? If we look back over what we have explained to him, we find that he must take at least five different RMD distributions.Finally, the client has two Roth IRA accounts. He can forget about these accounts – at least as far as RMDs go. Roth IRAs have no RMDs during the account owner’s lifetime.

WHAT HAPPENS WHEN A CLIENT GETS RMD AGGREGATION WRONG?
There are two potential penalties when clients make RMD aggregation mistakes: the penalty for excess contributions and the penalty for missed RMDs.

THE 6% PENALTY
RMDs that are rolled over to another retirement plan create an excess contribution in the receiving account, which must be corrected as soon as possible.

When an excess contribution is corrected by Oct. 15 of the year after the year for which the contribution was made, the amount of the excess, plus/minus gains/losses attributable to the amount of the excess contribution must be removed from the account as well.

Simply taking a distribution from the receiving account in the amount of the RMD later in the year does not correct this problem. The IRA custodian must be informed that the distribution is a return of an excess contribution. The coding on the 1099-R for the distribution will reflect that it is a return of an excess contribution. There will be no 6% penalty when the excess is corrected in a timely manner.

When the form is not filed, the statute of limitations does not start to run for the excess contribution. If the IRS discovers the problem at any later date, they can assess the penalty, plus interest, assess failure to file penalties, plus interest, and, if the amount is large enough, assess accuracy-related penalties, plus interest.Excess contributions that are not corrected are subject to a penalty of 6% per year for every year they remain in the account. Form 5329 should be filed with the IRA owner’s tax return to report the excess contribution and to calculate the 6% penalty. This form is considered a separate tax return, so it can be filed as a stand-alone return.

THE 50% PENALTY
When a distribution is taken from the wrong type of account, you have a missed RMD. For example, suppose a client accidently takes their 403(b) RMD from their IRA. This is against the rules. The client has a missed RMD in the 403(b). The penalty for a missed RMD is a steep one – it is 50% of the amount not taken.

It’s critical for advisers to understand which RMDs can be combined and which accounts must distribute their own RMDs, and to communicate this to their clients. There are too many mistakes made in this area, and incorrect advice often comes from the plan or custodian.Here’s the good news. The client can generally rectify this issue. First, they should immediately take the missed 403(b) RMD. Then, they should file Form 5329 to report the missed RMD and follow the instructions to request relief. Assuming the client can show reasonable cause for the mistake, there's a good chance the IRS will waive the 50% penalty.

How to Pay Less Taxes on your RMDs (Required Minimum Distributions from IRA) and what is a QLAC? by Natalie Choate

Age 70 1/2: Think Through Your RMD Choices

Buying a qualified longevity annuity and tactically timing the first RMD could reduce the tax hit.

Natalie Choate, 05/08/2015

In 2015, we are looking at planning ideas for different life stages. This month: The year the IRA owner reaches age 70 1/2.

The year the IRA owner reaches age 70 1/2 is his or her first "distribution year." It's the first year for which there is a required distribution. Unlike with later years, however, the IRA owner gets a one-time special break in the age 70 1/2 year: The minimum distribution for that year is not required to be taken until April 1 of the following year. In all other years for which there is a required minimum distribution, or RMD, it must be taken by Dec. 31 of the distribution year.

If the client's income is still "too high," and he or she doesn't want or need to take the RMD to pay living expenses, continue to look for ways to reduce the RMD, such as rolling into an employer plan if still working, Roth conversions, or purchasing a qualified longevity annuity (QLAC), discussed below. (This tactic could also be used in years prior to the age 70 1/2 year.)

Buy a QLAC?A longevity annuity is an annuity contract that does not start paying you until you reach age 85. It eventually pays you a life income, but the income does not start until that later age, meaning that your investment (if made when you are many years younger than 85) has many years to accumulate and grow, so the income you eventually get will be larger. The purpose is to insure against "living too long"--outliving your income.

Normally such delayed annuities are not "legal" investments for IRAs, because the minimum distribution rules require IRA-owned annuities to start paying out no later than age 70 1/2.

But the IRS has made an exception to permit IRAs to purchase "qualified" longevity annuities (QLACs) with up to $125,000 of the IRA balance, or 25% of the IRA owner's total IRA balance if less. When the QLAC is purchased, the purchase price and value of the QLAC cease to be counted as part of the IRA balance for purposes of computing the IRA's annual RMD, beginning the year after the year of the purchase.

Suki Example: Suki is turning age 70 1/2 and age 71 in 2015. She plans to keep working (and therefore expects to continue to be in a high tax bracket) for at least another five years. Her projections show she will have a comfortable income even after retirement, though if she lives to a very old age, it could become questionable. She finds a QLAC that will pay her a good income starting at age 85, in about 15 years. She buys it inside her IRA for $125,000. By removing $125,000 from her account value "base" in 2015, this move will reduce her next year's IRA RMD (i.e., 2016) by $4,883, saving her about $1,900 of income taxes that year. Equivalent savings will accrue each year thereafter until the QLAC starts paying out. If the contract makes sense for her, the tax savings is a nice little bonus. Of course her income (and taxes) will go up when she reaches age 85 and starts collecting on the QLAC, but she won't be working then (she figures), so she won't mind the taxable income as much.

You can also buy a QLAC in your IRA earlier or later than the year you reach age 70 1/2. The earlier you buy it, the longer your $125,000 investment has to accumulate and thus reduce your RMDs pre-age 85 by an even larger amount. The longer you wait to buy it, the less of a good deal it is and the less value it has for reducing RMDs.

Take the RMD This Year or Next Year?Since you have a choice, which is better? Take the age 70 1/2 year RMD in the age 70 1/2 year? Or postpone it until the age 71 1/2 year? Despite a magazine article that said "never postpone the first year's RMD!" this is actually something that needs to be decided on a case-by-case basis.

In a few cases, the choice will be easy.

Don't postpone the first year's RMD if…Someone who needs the age 70 1/2 year distribution to pay immediate living expenses will obviously not postpone. A person who is in a more or less steady income tax bracket, but whose RMDs are large enough that bunching two of them into one year would push him into a higher bracket in the age 71 1/2 year, should presumably not postpone. Postponement will not be possible if the participant desires to do a rollover or conversion from the plan in 2015: The RMD must be distributed before the account can distribute money for a rollover or conversion.

Do postpone the first year's RMD if… Someone is still working and earning a high income, but plans to retire later in the age 70 1/2 year, so expects to have a substantially lower income next year. Someone who is leaving his entire IRA to charity will probably postpone, since if he happens to die before taking the RMD that is just a little more money that will go the charity at his death income tax-free. Anyone who wants to maximize the amount of the IRA that will pass to her beneficiaries upon death should postpone taking the RMD as long as possible, in case he or she dies prior to the postponed distribution deadline.

The close cases…For others, the choice is not so easy. A client who expects to be in the same bracket next year as this year might decide based on personal preference: "Jack" takes his RMD early in his age 70 1/2 year, to "get it over with." His sister "Jill" postpones because, even though it looks like her bracket will be just as high next year as it is this year, you never know--she might get lucky and be really poor next year after all, making postponement profitable.

The person who thinks that postponing is always a good idea because you defer the taxes a little longer should remember that postponing actually increases the amount of the second year's RMD … because the age 70 1/2 year RMD that you did not take in the age 70 1/2 year is still part of the account balance at the end of the year!

One thing is sure: Postponing the RMD to the age 71 1/2 year creates complications. If the first year's RMD is postponed, two RMDs are required in the second year, and the two RMDs in the second year will have different deadlines, be based on different account balances, and use different divisors!

Bernie Example: Bernie turns age 70 1/2 in 2015, so 2015 is the first distribution year for his IRA. To calculate the 2015 RMD, he uses the 2014 year-end account balance and the Uniform Lifetime Table divisor for the age he attains on his 2015 birthday, which will be 70 if he was born before July 1, or 71 if he was born after June 30. He can take the 2015 RMD at any time from Jan. 1, 2015, through April 1, 2016. There will then beanother RMD for the year 2016, which must be taken between Jan. 1, 2016, and Dec. 31, 2016. The 2016 RMD will be based on the Dec. 31, 2015, account balance and will use the Uniform Lifetime Table factor applicable for the age he attains on his 2016 birthday.

Resources: See Natalie Choate's book Life and Death Planning for Retirement Benefits(7th ed. 2011) for full details on the required beginning date and the first distribution year. The book is available as a paperbound "real" book at http://www.ataxplan.com/ or in an electronic (online) edition by subscription athttp://www.retirementbenefitsplanning.com/.

Inherited IRA Tips (Forbes Magazine)

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Inherited IRA Rules: What You Need To Know

Many people who inherit IRAs are unfamiliar with the rules that apply to them. My article for Forbes magazine, “Five Rules For Inherited IRAs,” gives a broad overview of the subject. In this post I answer questions from two readers with concerns that affect other people, too.

Michael Twersky, a 26-year-old consultant in New York, asks:

I inherited a $15,000 traditional IRA from my father. As a child beneficiary, will I avoid income tax upon withdrawal if I wait until I’m 60? If not, would it be better to withdraw now while I’m still in a pretty low tax bracket?

You don’t have the option of waiting until you are 60 to take withdrawals. Generally, non-spousal IRA heirs must withdraw a minimum amount each year, starting by Dec. 31 of the year after the IRA owner died. Note: This is true whether it’s a traditional IRA or a Roth (a common misconception).

To calculate this distribution, you take the balance on Dec. 31 of the previous year and divide it by the inheritor’s life expectancy, as listed in the IRS’ “Single Life Expectancy” table. (You can find the table in IRS Publication 590, “Individual RetirementArrangements (IRAs),” which downloads here as a PDF.) Unless the account is a Roth, there is income tax on this required payout.

Don’t make the mistake, as some people do, of using the number from the table to figure a percentage. In subsequent years, you simply take the number you used in the first year and reduce it by one before doing the division.

If they choose to, IRA inheritors can draw out these minimum required distributions over their own expected life spans, as explained here. This is known as the stretch-out – a financial strategy to extend the tax advantages of an IRA. Stretching out the IRA gives the funds extra years and potentially decades of income-tax deferred growth in a traditional IRA or tax-free growth in a Roth IRA. This is a wonderful investment opportunity.

If you weren’t aware of the minimum distribution requirement and have not taken the required withdrawals, see my post, “What Happens When IRA Inheritors Miss A Key Deadline.”

6/09/2010 @ 6:00PM

Five Rules For Inherited IRAs

Before they inherited $3 million in retirement accounts from their father last year, the three middle-aged siblings didn’t know it was possible for heirs to stretch out the tax benefits of such accounts for decades. But what they also discovered after his death is that doing this is tricky–and in some cases impossible–if the original owner of the accounts didn’t fill out his beneficiary forms just so. Although their 78-year-old dad was a lawyer, “He may never have realized that it made any difference,” says a daughter, who has spent days trying to sort it all out.

Whether you’re inheriting an IRA or aiming to protect your own heirs, you’ve got to dance the IRS jig.

1. First, do no harm.

If you inherit a retirement account, don’t do anything until you know exactly what rules apply. With your own IRA you can take the money out and redeposit it in another IRA within 60 days without penalty. Not so an inherited IRA. All movement of money must be from one IRA custodian to another–be sure to specify a “trustee-to-trustee” transfer. Moreover, unless you’ve inherited from a spouse, you must retitle the IRA, including the original owner’s name and indicating it is inherited, e.g., “Daddy Warbucks, deceased, inherited IRA for the benefit of Little Orphan Annie, beneficiary.”

If two or more people are named as beneficiaries, ask the custodian to split it into separate inherited IRAs. That avoids investment squabbles and allows a longer stretch-out for the younger heirs.

2. Beneficiary forms rule.

The beneficiary form on file with the custodian of an IRA controls both who inherits it and its ability to be stretched out. If people other than a spouse are named as heirs, they must begin taking distributions from the account by Dec. 31 of the year after inheriting, but they can draw these out over their own expected life spans, enjoying decades of income-tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA. To give your heirs maximum flexibility, name both primary and alternate individual beneficiaries–say, your spouse as primary and kids as alternates or your kids as primary and grandkids as alternates. Your primary beneficiary then has the option of “disclaiming” or turning down the account, enabling it to pass to the younger alternate.

By contrast, if an estate is named as beneficiary, tax deferral is cut short. If it’s a Roth IRA, all funds must be withdrawn within five years. For a traditional IRA the same rule applies unless the former owner was already 70 1/2–the age at which a traditional IRA owner must begin cashing out. In that case the distribution rate for the heir is based on the age of the person who died, notes Rockville Centre, N.Y. CPA Edward Slott.

What if there’s no beneficiary form on file? Heirs are at the mercy of the IRA custodian’s default policy. Vanguard Group and Ameriprise award an IRA first to a living spouse and then to the estate. Merrill Lynch sends it straight to the estate. Few custodians will pass on an IRA directly to the kids without a beneficiary form.

3. Employer plans are different.

By federal law the money in a 401(k) goes to a spouse, unless he or she has signed a form waiving rights to it. But some employer plans will allow the funds to go straight to the kids if no spouse is living and no beneficiary form is on file. On the other hand, employers usually won’t let nonspouse beneficiaries stretch out 401(k) withdrawals. These beneficiaries should ask the employer to transfer the money into an inherited IRA. They can then divide it into separate inherited iras, says Natalie B. Choate, a lawyer with Nutter McClennen & Fish in Boston.

4. Spouses have more options.

A spouse who inherits–let’s assume it’s the wife–has an option not available to other inheritors. She can roll the assets into her own IRA and postpone distributions from a traditional IRA until she turns 70 1/2. The catch is, like other IRA owners she may have to pay a 10% early-withdrawal penalty if she takes money before age 59 1/2 from her own IRA. So a young widow should generally wait until after reaching 59 1/2 to do the rollover, says Brooklyn, N.Y. CPA Barry C. Picker. Meanwhile, she doesn’t have to take out any money until her late spouse would have turned 70 1/2.

5. Watch for distribution traps.

If the late IRA owner was 70 1/2 or older, beneficiaries must make sure the owner’s mandatory distribution for the year of death is withdrawn before doing anything else. When nonspouse beneficiaries take their own payouts, they should be aware of two quirks. First, if the estate paid estate tax, they may be able to take an itemized deduction to offset some IRA income. Second, the minimum is calculated differently than for your own IRA. You take the balance on Dec. 31 of the previous year and divide it by your life expectancy listed in the IRS’ “single life expectancy” table, rather than the table used by IRA owners. The next year you use the same life expectancy, minus a year. (With your own IRA, you take a new life expectancy from a table each year.)

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