As many of you know, the Internal Revenue Service requires a retirement plan account owner to begin annual withdrawals in the year that he or she reaches 70 1/2, provided they are no longer working. Required Minimum Distributions (RMDs) are a necessary evil, but at Truepoint we work with clients to evaluate the alternatives to ensure we meet their short- and long-term goals.
Retirees have an option to postpone their first RMD and should work with an advisor to determine whether or not this would be beneficial. If income is estimated to be higher in the first year than the second, the postponement option should be considered. In addition, the RMD may cause a greater portion of Social Security benefits to be taxable, so it’s important to analyze the effects on the taxability of benefits in deciding whether to postpone the first year’s RMD.
Leveraging Charitable Giving
One way to reduce the tax impact is to donate the RMD to charity directly from the IRA. Congress has extended the provision through 2011 that allows individuals aged 70 1/2 and older to transfer tax-free up to $100,000 per year from their IRA to public charities. For a number of reasons, donating directly from an IRA may save more tax dollars than a cash gift. For example, if deductions are not itemized, a cash gift would not be deductible. However, in this case, a charitable distribution from an IRA could still lower the tax burden by reducing the adjusted gross income. If an RMD is not used for charitable purposes, the IRA distribution increases the adjusted gross income. This increases the taxability of Social Security benefits. It also decreases the deductibility of medical expenses and increases Medicare premiums. All of these drawbacks can be avoided and still fulfill the RMD requirement by transferring directly to a charity.
Consider In-Kind Distributions
Truepoint investment portfolios contain exchange traded funds and mutual funds as a part of their asset allocation. For those clients with additional resources who do not need the cash flow from a required distribution, we recommend transferring holdings from the IRA to a non-retirement account via an in-kind distribution (shares of exchange traded funds or mutual funds are transferred to a non-retirement account in an amount approximately equal to the required distribution). Because no shares are sold, this prevents the overall allocation from being disturbed and still creates the taxable event required by the IRS.
Taking Advantage of Tax Withholding
If an individual pays quarterly income tax payments to the state or federal government and does not need some or all of the funds from the RMD, we can plan to withhold state and federal tax amounts from an IRA distribution late in the tax year. Typically, individuals are required to make equal quarterly payments for estimated taxes. However, these payments can often be replaced with tax withholdings from an IRA at any point during the year. Withholding taxes from a retirement account in December would not trigger any penalties for lack of payment earlier in the year. When your payment is made in December, it is similar to an interest-free loan from the government throughout the course of the year.
If you have any questions about these alternatives, your Truepoint advisor would be happy to discuss them in more detail.
For more information, please contact Lisa Reynolds at 513.792.6648 or firstname.lastname@example.org.