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Key date approaching in 2014 for older clients with IRAs and qualified plan accounts

March 18, 2014

A critical date is approaching for many clients who attained age 70 1/2 in 2013. By Apr. 1, 2014, these clients must commence making required minimum distributions (RMDs) from their traditional 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 the 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 (a) the account owner’s spouse and (b) more than 10 years younger than the owner. In this instance, 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))

RIA caution: The Apr. 1 required beginning date is critical because failure to begin RMDs could expose the taxpayer to a penalty tax equal to 50% of the difference between the amount that should have been withdrawn and the amount that was withdrawn.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.

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.

RIA observation: A taxpayer attained age 70 1/2 in 2013 if he was born after June 30, ’42, and before July 1, ’43.

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.

RIA illustration June has two separate IRAs. The RMD from IRA-A is $8,000 and the RMD from IRA-B is $7,000. June may take her total $15,000 RMD from either IRA-A or IRA-B, or take distributions from both as long as the total IRA payout for the year is $15,000.
RIA 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 to avoid an amount being automatically withdrawn from them.
RIA caution: RMDs from inherited IRAs must be figured separately from required minimum distributions from IRAs in the taxpayer’s own name.

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 2014. 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 2014 should consider taking their first year’s RMD during 2014, rather than waiting until 2015. Doing so may avoid a “bunching” problem in 2015.

RIA illustration Angela attains age 70 1/2 in 2014 and her aggregated RMD for all her IRAs for that year is $35,000. For simplicity, assume her aggregated IRA-RMD for 2015 also will be $35,000. If Angela waits until March of 2015 to take the $35,000 RMD for her first distribution year (2014), she will have to withdraw another $35,000 from her IRAs by the end of 2015. Both amounts will be included on her 2015 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.
RIA 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 part or all of the benefits of a state pension/retirement income exclusion for the first distribution year.
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, the deduction for casualty losses, and the personal exemption phaseout (PEP) and the itemized deduction (Pease) limitations.


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.
…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 for a longer period of time.
…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.


RIA caution: Taxpayers considering a rollover from a regular IRA to a Roth IRA should keep in mind that RMDs cannot be part of the rollover.
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