How to Plan for the Largest-Ever IRAs and RMDs

The surge in stock and bond prices in late 2023 brought benefits but created tax problems for some IRA owners.

Some IRA owners must take required minimum distributions (RMDs) each year. The year’s RMD is based on the IRA’s value on Dec. 31 of the previous year.

The rise in stock and bond prices means 2024 RMDs are higher than they would have been a couple of months before the end of 2023 when stock and bond prices were declining. You have to take RMDs based on that end-of-2023 value, even if the IRA’s value declines during 2024.

RMDs are a tax problem for owners of traditional IRAs who have other income and assets and don’t need the IRA distributions to pay their living expenses. They’re forced to take taxable distributions from their IRAs. The RMDs results in income taxes on income they don’t need and could push them into higher income tax brackets or trigger one or more of the Stealth Taxes.

Original owners of Roth IRAs don’t have RMDs.

Most beneficiaries of inherited traditional and Roth IRAs must fully distribute the IRAs within 10 years after inheriting them and might have to take RMDs from years one through nine.

But RMDs for inherited IRAs are a separate topic. The rest of this article is about RMDs for the original owners of traditional IRAs.

The beginning age for RMDs changed several times in recent years. Under the current rules, the beginning age is 72 for those born before 1951, 73 for those born from 1951 through 1959 and 75 for those born in 1960 or later.

It is important to distribute at least the full amount of the RMD by Dec. 31. The IRS realized a few years ago that many people weren’t taking RMDs or were calculating them incorrectly. So, the IRS stepped up its tracking and enforcement of RMDs and is quick to impose penalties for failing to distribute the entire RMD by Dec. 31.

The good news is that the penalty for missing RMDs finally is reduced. Now, it’s only 25% of the amount that should have been withdrawn but wasn’t, instead of the longstanding 50%.

In addition, the penalty can be reduced to 10% if the mistake is corrected in a timely manner. To qualify for the 10% penalty, you generally must take the RMD before the IRS sends you a notice of deficiency or before the last day of the second taxable year that begins after the year in which the RMD should have been taken, whichever is earlier.

The penalty can be avoided by convincing the IRS to waive it because you had a reasonable cause for missing the RMD. But there’s no guarantee the IRS will waive the penalty. If you take the time to apply for a waiver and the IRS denies the request, then it probably will be too late to qualify for the 10% penalty and you’ll be stuck with the 25% penalty.

Most IRA custodians compute the RMD for their customers and include it in at least one of the monthly statements or the online account.

But you don’t want to rely on this computation. In a recent case, an IRA owner sued the custodian because the custodian had the wrong birth date for the customer in its records and computed the wrong RMD amount. The customer was hit with the penalty by the IRS.

To compute your RMD for 2024, take the December 31, 2023 account balance for each traditional IRA. Then go to IRS Publication 590-B, available free on the IRS website at www.irs.gov.

In the back of the publication are the life expectancy tables. Most people use Table III; married people whose spouses are more than 10 years younger than they are use Table II. Beneficiaries use Table I.

Find your life expectancy factor in the table. Divide the IRA value by the life expectancy factor. The result is your RMD for this year.

Knowing some key rules and strategies can help you plan to minimize taxes on the RMDs and optimize their effect on your finances.

Don’t forget 401(k)s. Most of the RMD rules for traditional IRAs also apply to traditional 401(k)s and other non-Roth qualified employer retirement plans. Don’t forget to take RMDs from the employer plans you still belong to. Some people can delay RMDs from 401(k)s, as I explain in the next article.

First-time RMDs. The first RMD must be taken by April 1 of the year following the year you turn what the IRS calls the required beginning date, which is 73 for those starting RMDs this year. If you turn 73 in June 2024, you have until April 1, 2025, to take that first RMD.

But it is considered your 2024 RMD even if you take it in early 2025. You probably want to take that first RMD by December 31, 2024. Otherwise, in 2025 you must take the 2024 RMD, plus your 2025 RMD has to be taken by December 31, 2025.

That would give you two RMDs in one year and could push you into a higher tax bracket. (You use the December 31, 2023, account balances to calculate the 2024 RMD, even if you don’t take it until 2025.)

Which accounts to draw down. Many people have multiple traditional IRAs. The rules let them compute the RMD for each IRA and then add the individual RMDs into one aggregate RMD.

The aggregate RMD can be taken from the traditional IRAs in any proportion you want.

The aggregate RMD can be taken from one IRA, or roughly equal amounts can be taken from each IRA. Or you can take the aggregate amount in any ratio you want. The only requirement is that by Dec. 31 the total distributions from your traditional IRAs at least equal your aggregate RMD.

Some people decide to simplify their finances over time by using the aggregate RMD to fully empty one IRA first.

Others established separate IRAs for each of their beneficiaries and use the RMDs to keep the balances equal.

Another strategy is to use the RMD to rebalance the overall portfolio. For example, if you decide you have too much invested in stocks, the RMD can be taken from the IRA that owns the most stocks.

The aggregation rule applies only to traditional IRAs of original owners.

Balances of inherited IRAs and any employer plans, such as 401(k)s, can’t be aggregated. They’re computed and taken separately. There’s an exception for inherited IRAs that all were inherited from the same owner.

The form of your distribution. Your RMD doesn’t have to be cash. There’s no need to sell assets to make the RMD. You can take the RMD in property, known as an in-kind distribution.

For most IRAs, an in-kind distribution involves simply directing the custodian to transfer a certain number of shares of a mutual fund or stock from the IRA to a taxable account with the custodian or another financial institution.

The value of the investment on the date of the distribution counts toward your RMD and is your tax basis of the asset in the taxable account. You must be sure the total value of the assets on their distribution dates at least equals your RMD.

The in-kind distribution is especially helpful when your IRA owns unconventional assets, such as real estate, mortgages, or a small business. It is hard to sell only a portion of such assets to make the RMD. Instead, make an in-kind RMD by transferring title to a portion of the asset to you.

Timing distributions. You can take the RMD at any time during the year.

Some people schedule monthly distributions because they like the regular cash flow. Others take the full RMD early in the year to be sure the task is done. Still others wait until the end of the year. They want to maximize the tax-deferred gains and income earned by the IRA, and they want to delay paying estimated taxes on the distributions.

1. Rowe Price did a study some years ago comparing RMDs taken at the end of the year to those taken early in the year. It found that the IRA lasted longer when RMDs were delayed until late in the year.

But the study was done using a period when the stock indexes increased most years. The result would be different in a declining market or if the IRA had less invested in stocks. You have to decide the timing strategy that is best for you.

Year-of-death distributions. The rule for year-of-death RMDs is one reason to consider taking the RMD early in the year.

When someone has reached the required beginning date, the RMD has to be taken for the year in which the person died. If the owner didn’t take the RMD before passing, then the main beneficiary of the IRA has to take the RMD and include it in his or her gross income.

Failing to take the RMD means you pass on a tax liability to the beneficiary. It also means the beneficiary has to know to check whether you took the RMD before passing away. The beneficiary could be hit with the penalty for underpaying an RMD if he or she doesn’t know to take the year-of-death RMD.

Qualified charitable distributions. One way to satisfy the RMD obligation without incurring taxes is to take the RMD as a qualified charitable distribution (QCD). QCDs are discussed in detail in the February 2024 issue of Retirement Watch. Review it to decide how to integrate QCDs into your RMD planning.

Multiple IRAs. The law allows you to combine or split IRAs without tax consequences. It is best to make any changes with direct trustee-to-trustee rollovers instead of trying to transfer the money yourself.

There can be good reasons to have multiple IRAs.

When there is more than one beneficiary, some people want to maintain a separate IRA for each beneficiary. The alternative is the beneficiaries could inherit one IRA jointly and split it tax-free after inheriting.

Managing multiple IRAs can make life more difficult for you, Also, the investment returns of and distributions from the IRAs might be different, so the beneficiaries might not inherit the same amount unless you move money around to equalize the IRA values.

Some people have multiple IRAs to segregate assets. For example, you can buy a qualified longevity annuity contract (QLAC) in an IRA, and RMDs aren’t required from that portion of the IRA until age 85 or income is paid from the QLAC. Your life might be simpler if you establish a separate IRA that holds only the QLAC. See our July 2022 issue for details about QLACs.

Also, an IRA that was created by a rollover from a 401(k) might have greater creditor protection than other IRAs under state law as I discussed in the February 2024 issue.