Many taxpayers have multiple Individual Retirement Accounts and 401(k) accounts, and as the baby boom generation enters its retirement years, more clients than ever are going to need advice from a tax professional about how to handle the complicated rules for required minimum distributions from the accounts once they finally retire.
This three-part special study offers an overview of lifetime RMDs to help tax practitioners and their baby boomer clients cope with this important financial and tax event—the onset of mandatory distributions from their traditional IRAs and qualified plans.
This third and final installment of the series covers lifetime RMDs from multiple IRAs, the potential role of qualified charitable contributions, and withholding on RMDs. The first installment explained when RMDs must commence, choices for first and second year required distributions, and how to satisfy the RMD rules. The second installment focused on calculating lifetime non-annuity RMDs.
Lifetime RMDs from Multiple IRAs
It is common for a taxpayer to have a number of different IRAs. Although there may be investment advantages in maintaining multiple accounts, they can create computational difficulties when the time comes to begin taking RMDs. The amount of each RMD must be 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.
Observation: This rule provides flexibility to owners of multiple IRAs. For example, if an IRA is invested in stocks or mutual fund shares whose price is temporarily depressed, the minimum distribution can be made from other IRAs invested in bonds or money market funds to avoid selling at a market low. Of course, the same goal can be achieved by having only one IRA invested in a variety of different investments at one financial institution, and then directing the institution to make RMDs from one or a variety of these investments.
Caution: Many financial institutions automatically place each year’s RMD in a separate non-IRA account. This procedure automatically avoids the risk of penalties for insufficient distributions. Taxpayers who want to take an RMD from an IRA held at another financial institution should notify the trustees or custodians of the IRAs from which they do not want to withdraw. Otherwise they may wind up having more money distributed than is necessary to satisfy the RMD rules.
The rule permitting amounts in IRAs to be aggregated for RMD purposes applies only to IRAs that an individual holds as an owner. It doesn’t apply to IRAs that an individual holds as a beneficiary. IRAs held by a person as a beneficiary of the same decedent may be aggregated, but can’t be aggregated with amounts held in IRAs that the individual holds as the IRA owner or as the beneficiary of another decedent. And no IRA can be aggregated with a Roth IRA to determine payouts.
Finally, the amount of each RMD must be calculated and paid separately for each qualified plan. Thus, 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, QA 2, separate accounts in a qualified plan aren’t aggregated in certain situations after the death of the account owner.
Recommendation: From the standpoint of simplicity (as well as possibly higher returns or lower account fees reserved for customers with larger holdings), a taxpayer who has one or several accounts in defined contribution plans, as well as IRA holdings, and is subject to the same required beginning date (RBD) for them, should consider consolidating the accounts, for example, by transferring them into an IRA at one financial institution.
RMDs and Qualified Charitable Contributions
Taxpayers who are age 70 1/2 or older may make tax-free distributions to a charity directly from an IRA of up to $100,000 per year. These distributions, called qualified charitable distributions, aren’t subject to the charitable contribution percentage limits since they are neither included in gross income nor claimed as a deduction on the taxpayer’s return.
Qualified charitable distributions should be considered by better-off, charitable-minded taxpayers who don’t need to withdraw money from their retirement plans, but must anyway because of the RMD rules.
This is because, although such distributions aren’t included in the taxpayer’s gross income, they are taken into account in determining his RMD for the year. For example, if a taxpayer’s IRA RMD for the year is $80,000, and he or she makes a $50,000 qualified charitable distribution from the IRA, another $30,000 withdrawal from the IRA will satisfy the year’s RMD requirement.
Qualified charitable distributions also should be considered by those who rely on their RMDs to supplement other retirement income, but regularly make charitable contributions to one or several organizations. The amount of the RMD distribution used to make a qualified charitable contribution will reduce adjusted gross income and as a result, may increase deductions and/or credits subject to an AGI floor, such as the deductions for medical expenses and casualty losses, and reduce the impact of the personal exemption phaseout (PEP) and the itemized deduction (Pease) limitations.
Withholding on RMDs
In general, federal income tax will be withheld on RMDs from defined contribution plans and traditional IRAs (in more technical tax parlance, these are designated distributions that are periodic payments).
The amount of tax withheld will be based on the taxpayer’s marital status and the number of withholding allowances claimed on his or her withholding certificate (Form W-4P). If none is in effect (i.e., Form W-4P isn’t filed), federal tax will be withheld as if the taxpayer is a married individual claiming three withholding allowances.
However, a taxpayer may elect on Form W-4P not to have tax withheld from RMDs (in which case he or she will have to reflect the RMD income in quarterly estimated tax payments). The election, which remains in effect until revoked (on Form W-4P) by the recipient, takes effect in the manner provided by Code Sec. 3402(f)(3) for withholding exemption certificates for wages.
Robert Trinz is a senior analyst with Thomson Reuters Checkpoint within the Tax Accounting business of Thomson Reuters.