Assume your clients are over 70 ½ and are subject to required minimum distributions (RMDs) on an IRA. You know they need to take that distribution in a timely manner, but that leaves a fairly wide window.
Should you encourage them to take their RMD now, early in the year? Should they wait until later in the year to take it?
There’s really no right or wrong answer. Rather, depending on your client’s specific circumstances, either can make sense. Here are a few factors to consider when making this decision:
Reasons to take RMDs early in the year
Clients don’t have to worry about the 50 percent penalty — RMDs must generally be taken by the end of the year for which they are required to be considered timely. For example, an RMD for 2015 must generally be taken by December 31, 2015 (there is an exception to this rule for the first year a client is required to take an RMD). Although the IRS can provide relief in certain circumstances, clients who miss the deadline leave themselves subject to a 50 percent penalty, assessed on the amount they were supposed to take, but did not.
Although December 31st seems a long way off, consider encouraging clients to take their RMDs now to avoid potential for error. It’s not uncommon for clients to postpone taking RMDs until later in the year, only to forget, become ill or otherwise preoccupied, leading to the deadline being missed.
Clients have much to worry about in retirement. But if they take their RMDs early in the year, a 50 percent penalty doesn’t have to be one of them.
Don’t leave client’s beneficiaries with a tight window — If clients are subject to required minimum distributions this year and they pass away before taking an RMD, their beneficiaries are required to take what would have been their RMD. To avoid a potential penalty, they should take that distribution before the end of the year.
The longer a client waits to take that RMD, the more difficult that becomes. For instance, if a client dies now, there’s probably more than enough time for their beneficiary to take any remaining RMD by the end of the year. If a client dies on December 15th, however, that’s not likely to happen.
In order for beneficiaries to set up an inherited IRA, they must often provide proof of an IRA owner’s death, such as by presenting a death certificate. At best, it may take days to receive a death certificate; at worst it can take several months or longer.
Plus, inherited IRAs can only be funded via a trustee-to-trustee transfer from a decedent’s account. Moving money this way can also be more time-intensive, taking several weeks in some cases.
Add all of this together and it’s easy to see why it may be next to impossible for a beneficiary to take a deceased IRA owner’s remaining RMD by the end of the year if the death occurs late in the year. Encouraging clients to take their RMDs earlier in the year greatly minimizes this issue.
The remainder of the account can be rolled over and/or converted — RMDs are considered to be the first money distributed out of an IRA owner’s account each year. Furthermore, RMDs are not eligible to be rolled over. Put those two rules together and you realize that, before you make any rollover — including a Roth IRA conversion — clients must take their RMD for the year.