Quick! Now’s the time to finish up your 2018 tax activities.
It’s coming up to the end of the year – time to make sure you have done all the tax “things” you need to do before the year ends. Can you defer any income to next year? Can you accelerate any deductions into this year? Do you need to sell losing investments to offset any gains? Have you contributed to your retirement accounts? Have you spent down your flex spending accounts? And, relevant to the point of this post: have you taken out your required minimum distributions (RMDs) for your IRA if required?
RMDs? Remind me what those are all about?
You’ve been saving and saving in your IRA or 401(k). For most of your life, those accounts have been a place to deposit money. But, when you reach 70 1/2 years, you are required to start withdrawing money in the form of required minimum distributions. (That’s only true for traditional IRAs and 401(k)s. The Roth versions don’t require minimum distributions.)
Side note – if you inherited retirement funds from someone who wasn’t your spouse, you probably have to take RMDs regardless of your age.
Why?
Congress doesn’t want you leaving your tax-deferred money sitting in these accounts forever. They let you defer your income taxes long enough, so now they want you to start paying up.
How much do I have to withdraw?
There’s a calculation to do based on your age. Generally, you have to withdraw a fraction where the top number is one and the bottom number is the number of years the government figures you’ll probably live. If, for example, you turned 75 this year, you have to divide your retirement account balance by 13.4 and withdraw at least that amount, which is about 7.5% of your account. But there are some wrinkles to the calculation, like where you are more than 10 years older than your spouse.
When?
In the first year you are subject to RMDs, you have a bit of extra time, but generally you have to get it done each and every calendar year by December 31.
What if I don’t?
Look, the penalty here is so awful that you don’t even want to mess with this. Take your darn RMD. Seriously. Because if you don’t, you have to pay a penalty equal to 50% of the amount you were supposed to withdraw. Yep, you read that correctly. Half. So if you were supposed to withdraw $20,000 and you didn’t, $10,000 of it goes to the government. Ouch.
What’s this do to my taxes?
Remember when you got to deduct your contributions on your tax return way back when you made the contribution to your IRA or 401(k)? That was pretty great, right? The consequence is that you’ve dodged income tax on that money for all these years. But it’s time to pay up – your RMD will be included as ordinary taxable income on your tax return. That could mean that you should be paying estimated taxes throughout the year. Or, you can opt to have a chunk withheld by the account custodian to pay your taxes. What it definitely means is you need to be doing some planning ahead of time and make sure you either know what you are doing or get some help.
What if I’d rather give my money to a charity than pay taxes?
Hey, great idea! You can do that. In fact, if you are going to do any charitable giving this year, you should almost always be gifting your RMD first. Let me show you why. Imagine a couple who want to donate to a charity of their choosing this year. They can either take their RMD and donate cash from their bank account, or they can instruct their IRA custodian to pay the RMD to the charity. If they choose the former, their RMD gets taxed as ordinary income, but they can deduct their gift to the charity. If they choose the latter, they do not get taxed on the RMD, but they do not get to deduct their gift to charity.
So which one is better? If the couple itemizes their deductions and can deduct the entirety of the gift, donating the RMD will be the same as receiving the RMD and donating something else. However, if the couple does not itemize or cannot deduct the entire gift, donating the RMD will always reduce their tax bill. So if you are inclined to give to charity, you should donate from your traditional IRA first, because it is the only way to make sure you get “credit” for the donation.
What’s the fine print?
Some notes: you can only do this with a traditional IRA – not a 401(k). So you may need to rollover your 401(k) to an IRA first. Also, each person can only donate up to $100,000 per year. (Listen, if you are going to donate $100,000 to a charity this year, you should pay someone to make sure that you are doing it correctly!) You do not have to donate your entire RMD – you can just do a portion – but you have to transfer the money directly from your IRA to the charity. If the IRA money touches your personal bank account, you will pay tax on it. Just tell your IRA custodian to do a monthly direct transfer to the charity and you’re done.
If you want help with this topic, or other slick ideas for managing your wealth, helping your family, or planning for death or disability, please call Learned Lawyer today. Or, better yet, just schedule a free consultation right now!
