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As an age-72-or-older IRA owner, you have options regarding when to take your annual “required minimum distribution” (or RMD). You can take it early in the year, take it in monthly or other periodic instalments, or wait until the last minute. Which is best?
Surprise–there is no one “best” time to take the RMD. Each option has pros and cons. The advantage of taking the RMD early in the year is, you get it over with. You don’t have to worry about that particular obligation again until next year rolls around. You can reinvest the distribution immediately, spend it gradually over the year, or do some of each. The get-it-over-with-early-in-the-year option is particularly popular with the cash-strapped: You know you have to take the money out of your IRA sometime this year, so you might as well do it now, rather than borrow money to pay your pressing obligations. And who knows, maybe some more cash will materialize from other sources later in the year and you won’t have to borrow (or take extra IRA distributions) at all.
But taking the RMD early in the year has drawbacks. If you pay your estimated taxes based on actual taxes owed each quarter, you will pay tax on your RMD early in the year if you received it early in the year, so you lose your use of that tax money sooner. Also, if Congress decides in the middle of the year to eliminate the RMD requirement for that year (as they did in 2020–eliminating the requirement in March 2020, after many people had already taken their 2020 RMDs), you will have to scramble to undo the RMD you already took–if it’s even possible to reverse it., you will have to scramble to undo the RMD you already took–if it’s even possible to reverse it.
Some advocate waiting until late in the year to take the RMD, to achieve several goals: Delay the income tax due on the distribution as long as possible, maximize deferred return inside the retirement account, and be able to take advantage of whatever new deals may pop up for RMDs during the year. Delaying the RMD until late in the year is also helpful for those who use the RMD to kill two birds with one stone–comply with the RMD requirement and pay their estimated taxes. See discussion of this idea below.
Another good (though somewhat gloomy) reason to wait as long as possible before taking your RMD is, if you have no need for these distributions and you are leaving your IRA to charity: If you die during the year, before taking the RMD, the RMD for that year will pass to the charity and never be subjected to income tax.
For those who use their RMDs as a source of regular retirement income payments, similar to an annuity or pension, a popular choice is to have the RMD paid in monthly installments, ideally with all applicable income taxes withheld and sent directly to the government. That gives the retiree a satisfying monthly income with no big tax surprise at the end of the year–an appealing setup for those who would like to spend their time traveling, gardening, or golfing rather than wrestling with paperwork or huddling with a tax advisor.
As to HOW (in what form) you should take that RMD, again there are choices, each with pros and cons. The first thing to consider is making your charitable contributions for the year directly from the IRA in the form of “qualified charitable distributions” (or QCDs). See this column from November 2016 for more on QCDs. This will almost certainly save you some income taxes, since it keeps the QCD portion of the RMD out of your gross income, and may permit you to take the standard deduction on your 1040. It may even lower your Medicare premiums two years hence.
Another tax-savvy way to use RMDs is to wait until late in the year, then direct the IRA provider to pay all or most of the RMD to the IRS (and applicable state government if you pay state income tax) as “withheld income taxes.” Taxes that are withheld from retirement plan distributions, like taxes withheld from wages, are “deemed” to have been paid ratably throughout the taxable year…. even if the tax is not actually withheld and paid to the government until just before the end of the year. The IRA owner may be able to reduce or eliminate his estimated tax payments otherwise owed on April 15, June 15, and September 15 of the applicable year, if those obligations are deemed satisfied via withholding from a late-in-the-year IRA distribution.
Do your beneficiaries care about how and when you take your RMDs? Not that they have a vested interest in their future inheritance of your IRA, but if you want to know how your RMD choices affect your beneficiaries, here’s the answer:
To the extent you haven’t taken, prior to your death, your RMD for the year of your death, your beneficiaries will be required to take it after your death. Presumably they won’t complain about that, since they are inheriting this undistributed amount that otherwise might have gone to somebody else under your will. But if you die late in the year without having taken the RMD, the beneficiaries are going to have to scramble to take it in time… and if you haven’t paid your estimated taxes for the year of your death (because you were planning to use the late-in-the-year withholding idea to take care of that), your executor may owe some penalties to the IRS for that failure. But all in all, unless there are strong odds of your death in the near future, your beneficiaries probably do not need to be part of your concerns about when and how to take your RMD.
Next question: Should you take your RMDs in cash or in kind? An “in kind” distribution means you distribute assets (such as stocks or bonds) instead of cash. Either way is a perfectly legal way to fulfill the RMD requirement, but cash is A LOT easier. There can be good reasons to distribute assets–for example, if there is an investment you would prefer to own outside the IRA–but absent a good reason, you have to deal with several issues when distributing assets that don’t exist with cash distributions, such as what value applies to the distribution. For purposes of computing income tax (and RMD fulfillment) with regard to that distributed share of stock, is the stock valued at its opening price, closing price, or average price on the day of distribution? Also, your basis in the stock going forward will be the fair market value on the date of distribution–but your financial firm’s computer may not recognize that and may keep showing the original (inside the IRA) purchase price as your “basis.” Avoid these headaches by paying RMDs in cash unless there is a darn good reason to distribute assets.
One question arises only in connection with the first RMD: Whether to take that first RMD during the first “distribution year” (year for which an RMD is required) or take advantage of the postponement permitted (for the first distribution year only) until April 1 of the following year. For example, for someone who turns age 72 in 2021, 2021 is the first distribution year for her IRA, but the 2021 RMD can be postponed until as late as April 1, 2022. Is it better to postpone the RMD to get additional deferral or take it in 2021 to avoid bunching two RMDs into 2022? This is something each participant must decide with the advice of a planner, keeping in mind the individual’s anticipated income levels for the two years and the likelihood of tax law changes.
One final question: Which account should you take your RMD out of? If you own multiple IRAs, you can choose to take the combined RMD for all of them from any one or more of them. This can be a good way to facilitate paying RMDs in cash, if one IRA has lots of cash and another contains only investments that would be difficult (or undesirable) to divide or sell: Just pay the RMD for all your IRAs from the cash-heavy one. This rule also helps get rid of superfluous accounts–take the RMD for all your IRAs from the smallest or most expendable one so in a few years that account will be closed. This ability to take all RMDs for the year from any one or more accounts also applies to 403(b) plans. However, it does not enable the IRA (or 403(b)) participant to combine his/her own IRAs (or 403(b) accounts) with any other type of account , or with any IRAs or 403(b)s he/she holds as beneficiary: An inherited IRA (or 403(b)) can only be combined (for this purpose of taking RMDs for all such accounts from any one of them) only with other inherited IRAs (or 403(b)s) held as beneficiary of the same decedent.
Where to read more: For more ideas about how to take distributions from retirement plans, see the author’s Special Report: The 200+ Best & Worst Planning Ideas for Your Clients’ Retirement Benefits, available at www.ataxplan.com. For details on income tax withholding rules for retirement plan distributions, see ¶ 2.3 of Life and Death Planning for Retirement Benefits (8th ed. 2019; www.ataxplan.com); for full details on the lifetime minimum distribution rules, see Chapter 1 of that book.
Editor’s Note: The reference to the elimination of the RMD requirement was changed to correct the year to 2020.
Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The 2019 edition of Choate’s best-selling book, Life and Death Planning for Retirement Benefits, is available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article do not necessarily reflect the views of Morningstar.