As a financial advisor, you are probably aware that self-directed Traditional IRA owners must begin taking required minimum distributions (RMDs) when they reach age 70½. But some of your clients may not be aware of this requirement, which could lead to some large penalty taxes. For those who are aware, they may be looking to you to introduce strategies to help them meet the requirements with minimum disruption to their investment and retirement income strategies.
According to a study of 2016 activity, RMDs play a significant role in IRA withdrawal behaviors:1
- More than 1/4 (27.1%) of Traditional IRA owners took withdrawals in 2016. The majority were taken by individuals ages 70½ and older, who are required to take an RMD each year. For those ages 71-79, 85.4% took withdrawals from their Traditional IRAs, whereas only 6.2% of Roth IRA owners (who are not required to take RMDs) took withdrawals.
- Only 22.7% of IRA owners in RMD status withdrew more than the required amount for the year. The larger the IRA balance, the more likely this was to occur.
- Those with lower IRA balances tended to take withdrawals in excess of the RMD amount. Almost half (49.3%) of those who took out more than the RMD had balances less than $5,000.
To learn more about RMD planning click here and review some RMD planning FAQs.
These statistics suggest that your high net worth clients prefer to delay their taxable IRA distributions as long as possible and are taking IRA distributions solely because they are required. Here are some steps you may want to introduce to help your clients reduce the negative effects unwanted RMDs may be having on their account balances or investments. These steps are also relevant for clients that have chosen to diversify their retirement assets using an alternative asset IRA custodian.
Timeliness – Educate your clients about their responsibility for ensuring the proper amount is distributed each year after turning age 70½. They have until April 1 of the year following the year they reach age 70½ to take their first RMD. Each subsequent year’s RMD must be distributed by December 31. If they wait to take their first RMD until the year following their 70½ year, they will receive two taxable distributions for the year.
If they miss an RMD, they will owe a 50% excess accumulation tax on the amount that wasn’t distributed.
Aggregation – Self-directed IRA owners may have most of their IRA assets tied up in alternative investments, which can be more difficult to liquidate. If an individual owns more than one IRA (including Traditional, SEP and SIMPLE IRAs), they may aggregate the RMD amounts for each IRA and distribute the total RMD amount from just one IRA or split the total amount among their IRAs in any way they choose. This allows alternative asset IRA owners to select which investments to liquidate across their various IRAs. As IRA owners reach age 70½, they may want to have some short term, low risk investments in at least one of their IRAs to liquidate as needed for RMD payments. This can be a powerful opportunity for financial advisors to help investors with portfolio planning across the alternative assets in their self-directed IRAs.
Notice and calculations – IRA custodians, like STRATA, are required to alert an IRA owner by January 31 each year if an RMD is due. As a service to you and your clients, STRATA will assist in calculating the precise RMD amount that needs to be taken for that year. Keep in mind that most custodians will wait for the IRA owner’s instructions before paying out an RMD because the IRA owner has the option to aggregate RMDs and satisfy the payment from a different IRA. Discuss options for setting up an automatic distribution schedule to simplify the distribution process for your clients and to ensure that their RMD is paid out each year.
Charitable giving – Individuals in RMD status may donate up to $100,000 tax-free to a qualified charitable organization through a Qualified Charitable Distribution (QCD) from an IRA. A QCD must be transferred directly from an individual’s IRA to the charitable organization. The QCD counts towards the individual’s RMD amount but is not included in the IRA owner’s taxable income for the year, allowing them to avoid income tax on the amount they are required to distribute from their IRA.
Roth conversion – Roth IRAs are not subject to the RMD rules while the IRA owner is alive. Roth IRA owners may allow assets to accumulate beyond age 70½ and provide a tax-free inheritance to their heirs. Because of this, some Traditional IRA owners may consider converting a portion of their pre-tax retirement savings to a Roth IRA before reaching age 70½. In the year of conversion, the pre-tax amounts converted must be included in the IRA owner’s taxable income. To avoid a big tax bill or being bumped into a higher tax bracket, an IRA owner may want to spread the conversion over several years. Once in the Roth IRA, distributions to either the IRA owner or heirs will be tax-free if the distribution is qualified (IRA owner had a Roth IRA for at least five years and the distribution was taken because the IRA owner reached age 59½, died, became disabled or purchased their first home.) Including a Roth IRA in a retirement income strategy enables IRA owners to avoid RMDs and diversify the tax impact of their retirement savings.
If you have questions about RMDs across different IRA types, including both traditional assets and alternative investments, please contact STRATA, a specialist in alternative asset IRA custody, at 866-928-9394 or Info@StrataTrust.com.
Footnotes
1 Employee Benefit Research Institute, Issue Brief No. 456, EBRI IRA Database: IRA Balances, Contributions, Rollovers, Withdrawals, and Asset Allocation, 2016 Update, August 13, 2018, www.ebri.org
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