Min­i­mum dis­tri­bu­tion rules gov­ern IRA ac­counts

Albuquerque Journal - - BUSINESS OUTLOOK - Jim Hamill

Areader asked if I will pro­vide a re­view of the re­quired min­i­mum dis­tri­bu­tion rules for IRA ac­counts. This is a com­mon ques­tion that we re­ceive in our firm, so it seems to be an al­ways timely topic.

Be­cause so many peo­ple have ei­ther con­trib­uted to Roth IRAs or have con­verted tra­di­tional IRAs into Roth ac­counts, I’ll also ad­dress the rules for Roth ac­counts.

The owner of an IRA must be­gin RMDs for the year in which he or she turns age 70½. A choice avail­able in the first year per­mits the ini­tial RMD to be de­ferred un­til April 1 of the year after the owner reaches 70½.

If the first dis­tri­bu­tion is de­ferred, then the owner must take two dis­tri­bu­tions in the year fol­low­ing the year in which the owner reaches 70½. Of­ten, bunch­ing the dis­tri­bu­tions causes the tax rate to be higher, in­clud­ing the tax ef­fects of any other items that may be based on re­ported ad­justed gross in­come.

Dis­tri­bu­tions may be taken over the owner’s life ex­pectancy or a joint life ex­pectancy with a des­ig­nated ben­e­fi­ciary. The life ex­pectancy for this pur­pose is re­de­ter­mined each year in a more fa­vor­able man­ner than the “sin­gle life” ex­pectancy dis­cussed be­low for in­her­ited IRAs.

The cal­cu­la­tion of the RMD is based on the bal­ance of the IRA on 12/31 of the year be­fore the year of the RMD (e.g., 12/31/2016 is used for cal­cu­lat­ing a 2017 RMD). The cal­cu­la­tion of the RMD is done separately for each IRA, but the ag­gre­gate RMD for the year may be sat­is­fied from one ac­count.

There are no RMDs for the owner of a Roth IRA. This is one of the key ad­van­tages of a Roth ac­count. How­ever, some­one who in­her­its a Roth IRA must take dis­tri­bu­tions.

If the IRA owner be­gins to take RMDs and then passes away, his or her ben­e­fi­ciary must con­tinue to take dis­tri­bu­tions. The rules for these dis­tri­bu­tions de­pend on the iden­tity of the ben­e­fi­ciary.

A spouse ben­e­fi­ciary has the most op­tions. The spouse may treat the IRA as their own, so that they are then sub­ject to the “nor­mal” dis­tri­bu­tion rules, with the spouse as the new owner of the ac­count. They may also treat it as an in­her­ited IRA and con­tinue RMDs over their life ex­pectancy.

Life ex­pectancy for an in­her­ited IRA is a bit dif­fer­ent than a reg­u­lar life ex­pectancy cal­cu­la­tion, be­cause it is re­duced by one year for each ad­di­tional year that the ben­e­fi­ciary lives. A “nor­mal” life ex­pectancy fig­ure does not get re­duced by one year for each ad­di­tional year the per­son lives.

A non-spouse ben­e­fi­ciary does not have the op­tion to treat the IRA as his or her own. There­fore, dis­tri­bu­tions must be­gin by 12/31 of the year after the owner’s death. These dis­tri­bu­tions may be based on the ben­e­fi­ciary’s life ex­pectancy, us­ing the sin­gle life rules.

Ob­vi­ously, life ex­pectancy dis­tri­bu­tions re­quire that the ben­e­fi­ciary have a mea­sur­able life. If the ben­e­fi­ciary fails this test (e.g., an estate, cer­tain trusts), the dis­tri­bu­tions are based on the owner’s (ta­ble) life ex­pectancy at death.

The rules are a bit dif­fer­ent if the owner passes away be­fore tak­ing RMDs. A spouse ben­e­fi­ciary has sim­i­lar rules to those dis­cussed above, but also has the abil­ity to with­draw the en­tire IRA bal­ance by 12/31 of the fifth year fol­low­ing the owner’s death.

Also, the spouse ben­e­fi­ciary who treats the ac­count as an in­her­ited IRA can de­fer tak­ing dis­tri­bu­tions un­til the year that the owner would have reached age 70½.

A non-spouse ben­e­fi­ciary who in­her­its the IRA be­fore the owner took RMDs

must be­gin dis­tri­bu­tions by 12/31 of the year fol­low­ing the owner’s death and based on the ben­e­fi­ciary’s sin­gle life ex­pectancy, or may use the five-year rule dis­cussed above.

When the ben­e­fi­ciary lacks a life ex­pectancy (again, an estate or cer­tain trusts), the en­tire IRA must be dis­trib­uted un­der the five-year rule if the owner dies be­fore tak­ing RMDs.

These rules are ob­vi­ously hard to di­gest and hard to ex­plain within the space lim­its of a col­umn. It is im­por­tant to have a qual­i­fied ben­e­fi­ciary des­ig­nated be­fore death and to en­sure any trust named as ben­e­fi­ciary qual­i­fies for life ex­pectancy dis­tri­bu­tions (a look­through trust).

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