Required Minimum Distributions on IRAs Are Back

RMDs from IRAs and other retirement plans are back in 2010 after being waived in 2009. Everyone born before July 1, 1939 is required to take a minimum distribution this year.*

“Most people think there’s nothing you can do to lessen the tax impact of RMDs, but some planning moves can help certain individuals,” says Rebecca Pavese, CPA, manager of Palisades Hudson Financial Group’s national tax practice in Atlanta.

If you had a bad year or big deductions—or if your tax rate will increase in 2011--consider taking a large distribution this year. If you’re in an unusually low tax bracket in 2010 because you had lower income than usual or large deductions, consider taking more than the required minimum.

Additionally, someone who owns a business with a 2010 net operating loss might pay little or nothing in tax on an IRA distribution because the loss could offset it.

Many upper-income people may face higher taxes in 2011.

“If Congress doesn’t act, tax rates will increase next year. That’s another good reason to think about taking out more this year,” Pavese says. “But you might want to defer this decision until later this year to see what Congress does.”

Take the distribution as securities instead of cash. Most people take out their distributions in cash, but it’s not required. Instead, you can usually tell your IRA custodian to distribute securities in your plan to you. Instead of sending you say, $5,000 in cash, you can have the custodian distribute your 500 shares of XYX Co. or ABC Mutual Fund at $10 a share.

Once the stock or fund is in your taxable account, you can take advantage of lower long-term capital gains rates. If your shares appreciate to, say, $10,000 and you sell them five years from now, you’ll get the capital gains rate. But if you kept them in the plan, that $5,000 gain would eventually be taxed at higher, ordinary income tax rates when the money’s withdrawn.

“This can work especially well if you think the security is undervalued and you don’t need the cash,” Pavese says.

Give yourself a cushion in case the shares lose value by the time you receive them, Pavese cautions. Most custodians permit in-kind distributions.

Withhold money from your RMD to pay your income taxes. If you pay quarterly estimated federal income taxes, you can direct your IRA or plan custodian to withhold income tax from your RMD distribution. For instance, let’s say you owe $10,000 in 2010 tax. Normally, you’d have to make four payments of $2,500, but if you’re getting a $10,000 RMD, you can have the custodian withhold $10,000 in tax from it.

Since it’s withholding, it can all come at the end instead of throughout the year, and you won’t pay a penalty for underpayment of estimated tax.

“You get to hold onto and invest your money longer,” Pavese says.

RMDs are calculated based on your age and amount you have in your plan. The distributions count as ordinary income.

*You have until April 1 of the year following the year you turn 70½ to take the RMD. But, if you wait until the year after you turn 70½ you must take two distributions that year — one by April 1 and another by December 31. Going forward, you must take the RMD by Dec. 31.