Required Minimum Distribution Rules

Required Minimum Distribution Rules and When to Apply Them

In gen­er­al, required min­i­mum dis­tri­b­u­tion rules force the own­ers of IRA sav­ings and qual­i­fied plan accounts to take their first required min­i­mum dis­tri­b­u­tion (RMD) start­ing April 1, the year after they turn 70 1⁄2. The amount to be tak­en is from the IRS pub­lished RMD table. Fail­ure to do so results in a 50% penal­ty of the amount that should have been dis­trib­uted. How­ev­er, there are both IRS excep­tions as well as finan­cial plan­ning rea­sons that make it wise to start dis­tri­b­u­tions ear­li­er or later.

Why take IRA distributions early?

If the required min­i­mum dis­tri­b­u­tion rules requires that you begin dis­tri­b­u­tions at age 70 1⁄2, is there any rea­son to take ear­ly IRA dis­tri­b­u­tions? Yes.

Retirees of any age with large IRAs must under­stand that their IRAs can be hit with estate and income tax­es when they die. And RMD rules could cause future income tax bur­dens while they are alive. How­ev­er, clients between ages 59½ and 70½ have a great oppor­tu­ni­ty to use tax brack­ets to their advantage.

If they are in low­er tax brack­ets (10% or 15%), they can remove just enough mon­ey from their IRAs to use up those brack­ets. When they turn 70½, they will have reduced the amount sub­ject to Required min­i­mum dis­tri­b­u­tion (RMD). Their future tax brack­ets may be low­ered because of small­er with­drawals, and they will have shift­ed more of their assets out of their IRA. And most assets held out­side an IRA pass income-tax-free to beneficiaries.

Case Study

Bill and Lin­da are both retired, have large IRAs, and are age 60. Their tax­able income will be $30,000 this year.

Based on 2015 rates, the 15% tax brack­et to $74,900 for cou­ples fil­ing joint­ly. Thus, Bill and Lin­da could con­vert $44,900 worth of their IRAs to Roth IRAs this year and ful­ly use up their 15% tax bracket.

The fed­er­al income tax rate on the $44,900 con­ver­sion will be 15% ($6, 735). And after Bill and Lin­da hold the Roth IRAs for five years, they can with­draw all of the mon­ey tax-free. Each year they will repeat the process and con­tin­u­al­ly shift a large por­tion of their IRA to a Roth. If Bill and Lin­da had wait­ed until they were 70 ½ and sub­ject to RMD, the with­drawals may have pushed all of their income into a high­er tax bracket.

The rules above also apply to qual­i­fied plans as well. The excep­tion would be 457 retire­ment plans.