Adrian A. Hedwig
Financial Advisor, CUSO Financial Services, L.P.
Available at all Salal Credit Union branches
Don’t Forget About Your Required Minimum Distributions!
A withdrawal from an IRA is generally referred to as a distribution. Ideally, you would have complete control over the timing of distributions from your traditional IRAs. Then you could leave your funds in your traditional IRAs for as long as you wished, and withdraw the funds only if you really needed them. This would enable you to maximize the funds’ tax-deferred growth in the IRA, and minimize your annual income tax liability. Unfortunately, it doesn’t work this way. You must take what are known as required minimum distributions from your traditional IRAs.1
What are required minimum distributions (RMDs)?
Required minimum distributions (RMDs), sometimes referred to as minimum required distributions (MRDs), are withdrawals that the federal government requires you to take annually from your traditional IRAs after you reach age 70½. You can always withdraw more than the required minimum from your IRA in any year if you wish, but if you withdraw less than required, you will be subject to a federal penalty tax. These RMDs are calculated to dispose of your entire interest in the IRA over a specified period of time. The purpose of this federal rule is to ensure that people use their IRAs to fund their retirement, and not simply as a vehicle of wealth transfer and accumulation.
Tip: In addition to traditional IRAs, most employer-sponsored retirement plans are subject to the RMD rule. Roth IRAs, however, are not subject to this rule. You are not required to take any distributions from a Roth IRA during your lifetime.
When must RMDs be taken?
Your first RMD from your traditional IRA represents your distribution for the year in which you reach age 70½. However, you have some flexibility in terms of when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year. Since your first distribution generally must be taken no later than April 1 following the year you reach age 70½, this date is known as your required beginning date (RBD). Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until the following year, you will be required to take two distributions during that year–your first-year required distribution and your second-year required distribution.
Example: You own a traditional IRA. Your 70th birthday is December 2 of year one, so you will reach age 70½ in year two. You can take your first RMD during year two, or you can delay it until April 1 of year three. If you choose to delay your first distribution until year three, you will have to take two required distributions during year three–one for year two and one for year three. That is because your required distribution for year three cannot be delayed until the following year.
Caution: Your beneficiary generally must withdraw any distribution required for the year of your death if you haven’t yet taken it.
Should you delay your first RMD?
Your first decision is when to take your first RMD. Remember, you have the option of delaying your first distribution until April 1 following the calendar year in which you reach age 70½. You might delay taking your first distribution if you expect to be in a lower income tax bracket in the following year, perhaps because you’re no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution must be made on or by December 31 of that same year.
Receiving your first and second RMDs in the same year may not be in your best interest. Since this “double” distribution will increase your taxable income for the year, it will probably cause you to pay more in federal and state income taxes. It could even push you into a higher federal income tax bracket for the year. In addition, the increased income may cause you to lose the benefit of certain tax exemptions and deductions that might otherwise be available to you. So the decision of whether or not to delay your first required distribution can be crucial, and should be based on your personal tax situation.
Example: You are unmarried and reached age 70½ in 2016. You had taxable income of $25,000 in 2016 and expect to have $25,000 in taxable income in 2017. You have money in a traditional IRA and determined that your RMD from the IRA for 2016 was $50,000, and that your RMD for 2017 is $50,000 as well. You took your first RMD in 2016. The $50,000 was included in your income for 2016, which increased your taxable income to $75,000. At a marginal tax rate of 25 percent, federal income tax was approximately $14,521 for 2016 (assuming no other variables). In 2017, you take your second RMD. The $50,000 will be included in your income for 2017, increasing your taxable income to $75,000 and resulting in federal income tax of approximately $14,488. Total federal income tax for 2016 and 2017 will be $29,010.
Example: Now suppose you did not take your first RMD in 2016 but waited until 2017. In 2016, your taxable income was $25,000. At a marginal tax rate of 15 percent, your federal income tax was $3,289 for 2016. In 2017, you take both your first RMD ($50,000) and your second RMD ($50,000). These two $50,000 distributions will increase your taxable income in 2017 to $125,000, taxable at a marginal rate of 28 percent, resulting in federal income tax of approximately $26,988. Total federal income tax for 2016 and 2017 will be $30,275–almost $1,265 more than if you had taken your first RMD in 2016.
How are RMDs calculated?
RMDs are calculated by dividing your traditional IRA account balance by the applicable distribution period. Your account balance is calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made.3
Caution: When calculating the RMD amount for your second distribution year, you base the calculation on the total interest in the IRA or plan as of December 31 of the first distribution year (the year you reached age 70½), regardless of whether or not you waited until April 1 of the following year to take your first required distribution.
Example: You have a traditional IRA. Your 70th birthday is November 1 of year one, and you therefore reach age 70½ in year two. Because you turn 70½ in year two, you must take an RMD for year two from your IRA. This distribution (your first RMD) must be taken no later than April 1 of year three. In calculating this RMD, you must use the total value of your IRA as of December 31 of year one.
What if you fail to take RMDs as required?
If you fail to take at least your RMD amount for any year (or if you take it too late), you will be subject to a federal penalty tax. The penalty tax is a 50 percent excise tax on the amount by which the RMD exceeds distributions actually made to you during the taxable year.
Example: You own a single traditional IRA and compute your RMD for year one to be $7,000. You take only $2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at least $7,000 as a distribution but have taken only $2,000, your RMD exceeds the amount of your actual distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50 percent of $5,000), reportable and payable on your year-one tax return.
Technical Note: You report and pay the 50 percent tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to “reasonable error,” and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return, and attach a letter of explanation. The IRS will review the information you provide, and decide whether to grant your request for a waiver.
Like all distributions from traditional IRAs, distributions taken after age 70½ are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made nondeductible (after-tax) contributions or if you’ve ever rolled over after tax dollars from an employer-sponsored retirement plan to your traditional IRA. Since nondeductible contribution amounts were taxed once already, they will be tax free when you withdraw them from the IRA. You should consult a tax professional if your traditional IRA contains any nondeductible contributions.
Caution: Taxable income from an IRA is taxed at ordinary income tax rates even if the funds represent long-term capital gains or qualified dividends from stock held within the IRA. Special rules apply to Roth IRAs. Qualified distributions from Roth IRAs are tax-free. Even Roth IRA distributions that don’t qualify for tax-free treatment are tax free to the extent of your own contributions to the Roth IRA. Only after you’ve recovered all of your contributions are distributions considered to consist of taxable earnings. Further, special rules apply to distributions taken from Roth IRAs that have funds rolled over or converted from traditional IRAs.
When you take a distribution from your traditional IRA, there is no requirement that your IRA trustee or custodian withhold federal income tax on the distribution. However, the trustee or custodian generally will withhold tax at a rate of 10 percent unless you provide the trustee or custodian with written instructions that you do not want any tax withheld on the distribution. Even if tax is withheld at 10 percent, that may not be sufficient to cover your full tax liability on the distribution.
Tip: If you receive an annuity or similar periodic payment, tax withholding is generally based on your marital status and the number of withholding allowances you claim on your withholding certificate (Form W-4P). No withholding or waiver is needed when the distribution is a trustee-to-trustee transfer from one IRA to another (see below).
You first need to determine whether or not federal estate tax will apply to you. If you do not expect the value of your taxable estate to exceed the federal applicable exclusion amount, then federal estate tax may not be a concern for you. Otherwise, you may want to consider appropriate strategies to minimize your future estate tax liability.
For example, you might reduce the value of your taxable estate by gifting all or part of your RMD to your spouse or others. Making gifts to your spouse may work well if your taxable estate is larger than your spouse’s, and one or both of you will leave an estate larger than the applicable exclusion amount. This strategy can provide your spouse with additional assets to better utilize his or her applicable exclusion amount, thereby minimizing the combined estate tax liability of you and your spouse. Be sure to consult an estate planning attorney, however, about this and other strategies.
Caution: In addition to federal estate tax, your state may impose its own estate or death tax. Consult an estate planning attorney for details.
IRA rollovers and transfers
In general, there are two ways to transfer assets between IRAs, rollovers and trustee-to-trustee transfers. With a rollover, you receive funds from the distributing IRA and then complete the transfer by depositing funds into the receiving IRA within 60 days. A trustee-to-trustee transfer (also called a “direct rollover”) is a transaction directly between IRA trustees and custodians. If properly completed, rollovers and trustee-to-trustee transfers are not subject to income tax or the 10 percent premature distribution tax.
While you can’t make regular contributions to a traditional IRA for the year in which you turn 70½, or for any later year, there are no age limits for rollovers or trustee-to-trustee transfers. But you must remember to take your RMD each year after you reach age 70½ (you cannot roll over or transfer an RMD itself).
Tip: You can roll over (or transfer) funds from a traditional IRA to another traditional IRA or from a Roth IRA to another Roth IRA. Special rules apply to converting or rolling over funds from a traditional IRA to a Roth IRA. You may also be able to roll over or transfer taxable funds from an IRA to an employer-sponsored retirement plan.
60-day rollover: you receive the funds and reinvest them
With a rollover (sometimes called an “indirect rollover”), you actually receive a distribution from your IRA and then, to complete the rollover, you deposit all or part of the distribution into the receiving IRA within 60 days of the date the funds are released from the distributing account.
Example: On January 2, you withdraw your IRA funds from a maturing bank CD and choose to have no income tax withheld. The bank cuts a check payable to you for the full balance of the account. You plan to move the funds into an IRA account at a competing bank. Fifteen days later, you go to the new bank and deposit the full amount of your IRA distribution into your new rollover IRA. Your rollover is complete.
If you don’t complete the rollover transaction, or you miss the 60-day deadline, your distribution is taxable to you. However, there are several ways to seek waiver of the 60-day deadline, including an automatic waiver in some cases, self-certification if you missed the deadline due to one of eleven specified reasons, or by seeking a private letter ruling from the IRS. (If you roll over part, but not all, of your distribution within the 60-day period, then only the portion not rolled over is treated as a taxable distribution.)
Example: Assume the same scenario as the first example, except that when you receive your check from the first bank, you cash the check and lend the money to your brother, who promises to repay you in 30 days. As it turns out, he doesn’t repay the loan until March 5 (the 62nd day after your distribution). You deposit the full sum into the IRA account at the new bank. However, because you didn’t complete your rollover within 60 days, the January 2 distribution will be taxable (excluding any nondeductible contributions, as described above).
Caution: Under recent IRS guidance, you can make only one tax-free, 60 day, rollover from one IRA to another IRA in any one-year period no matter how many IRAs (traditional, Roth, SEP, and SIMPLE) you own. This does not apply to direct (trustee-to-trustee) transfers, or Roth IRA conversions.
If you roll over part, but not all, of your distribution within the 60-day period, then only the portion not rolled over is treated as a taxable distribution.
When you take a distribution from your traditional IRA, your IRA trustee or custodian will generally withhold 10 percent for federal income tax (and possibly additional amounts for state tax and penalties) unless you instruct them not to. If tax is withheld and you then wish to roll over the distribution, you have to make up the amount withheld out of your own pocket. Otherwise, the rollover is not considered complete, and the shortfall is treated as a taxable distribution. The best way to avoid this outcome is to instruct your IRA trustee or custodian not to withhold any tax. Unlike distributions from qualified plans, IRA distributions are not subject to a mandatory withholding requirement.
Example: You take a $1,000 distribution (all of which would be taxable) from your traditional IRA that you want to roll over into a new IRA. One hundred dollars is withheld for federal income tax, so you actually receive only $900. If you roll over only the $900, you are treated as having received a $100 taxable distribution. To roll over the entire $1,000, you will have to deposit in the new IRA the $900 that you actually received, plus an additional $100. (The $100 withheld will be claimed as part of your credit for federal income tax withheld on your federal income tax return.)
A trustee-to-trustee transfer occurs directly between the trustee or custodian of your old IRA, and the trustee or custodian of your new IRA. You never actually receive the funds or have control of them, so a trustee-to-trustee transfer is not treated as a distribution (and therefore, the issue of tax withholding does not apply). Trustee-to-trustee transfers are not subject to the 60-day deadline, or the “one rollover per 12 month” limitation.
Example: You have an IRA invested in a bank CD with a maturity date of January 2. In December, you provide your bank with instructions to close your CD on the maturity date and transfer the funds to another bank that is paying a higher CD rate. On January 2, your bank issues a check payable to the new bank (as trustee for your IRA) and sends it to the new bank. The new bank deposits the IRA check into your new CD account, and your trustee-to-trustee transfer is complete.
Trustee-to-trustee transfers avoid the danger of missing the 60-day deadline, and are generally the safest, most efficient way to move IRA funds. Taking a distribution yourself and rolling it over only makes sense if you need to use the funds temporarily, and are certain you can roll over the full amount within 60 days.
Converting or rolling over traditional IRAs to Roth IRAs
Have you done a comparison and decided that a Roth IRA is a better savings tool for you than a traditional IRA? If so, you may be able to convert or roll over an existing traditional IRA to a Roth IRA. However, be aware that you will have to pay income tax on all or part of the traditional IRA funds that you move to a Roth IRA. It is important to weigh these tax consequences against the perceived advantages of the Roth IRA. This is a complicated decision, so be sure to seek professional assistance.
This discussion pertains primarily to distributions from traditional IRAs. Special rules apply to Roth IRAs. This article applies to distributions to IRA owners. Special rules apply to distributions to IRA beneficiaries.
Life is for Living, and So Is Life Insurance
Life can be busy. The requirements of work and family often leave little time to step back and think about where you’ve been and where you’re heading. But as your responsibilities grow, so does the need to evaluate what would happen if life for you stopped. It’s a good idea to stop and take the time to reflect on how life insurance can help those you leave behind — the living.
Your spouse or life partner
A successful marriage is often predicated on sharing and providing for one another, and that includes each other’s financial obligations. If you were suddenly no longer in the picture, would there be enough money to pay for your final expenses, cover debt, and buy some time to allow your significant other to adjust to a new way of life? Life insurance can provide funds to cover immediate expenses and income to help support your surviving loved one.
You’ve worked hard to provide for your kids, to give them the chance to realize their hopes and dreams. Your children are likely your greatest responsibility — a responsibility that doesn’t end with your passing. Whether your children are in diapers or about to enter college, if something happened to you or your spouse, or both of you, would there be enough income to continue to provide financially for your children? Life insurance can help provide the resources for their continued growth and maturation.
Buying a home may be the largest single expenditure of your life. While being a homeowner is exciting, mortgage payments, often lasting 30 years, along with maintenance, utility costs, homeowners insurance, and real estate taxes can add up to a long-term financial commitment. Adequate life insurance protection can provide funds that could be used to cover these expenses, allowing your family to remain in their home.
Do you own your own business? Life insurance can fit into your business plan in many ways. It can be part of an employee benefit program, with coverage under a group plan. Life insurance purchased on the lives of certain key employees can protect your company from the loss of talented and valuable workers. And life insurance can be used to fund a buy-sell agreement.
Caring for an aging parent or loved one
Are you caring for an aging parent or loved one? Would the people who depend on you be able to afford quality health care and a comfortable place to live without your financial support? Life insurance can become extremely important in these situations, helping to provide for these individuals in the event of your death.
Planning for retirement
Preparing for retirement probably means you’re saving as much as you can in your 401(k), IRA, or other savings vehicle. If you die before you get to enjoy your retirement, will your retirement plan die for your surviving loved ones as well? Not only will your salary be unavailable to help pay for current living expenses, but your income won’t be there to build the nest egg for the retirement of your spouse or life partner. Life insurance can help provide funds that can be used for your spouse’s or life partner’s retirement.
Your health has changed
If your health declines, how will it affect your life insurance? A common worry is that your insurer could cancel your coverage should your health change. However, changes to your health will not affect your current insurance coverage, provided you continue to pay your premiums on time. In fact, you should take a closer look at your life insurance policy to find out if it offers any accelerated (living) benefits that you can access in the event of a serious or long-term illness.
Leaving a legacy
Life insurance can be used to increase the size of an estate for your heirs. The death benefit could provide your beneficiaries with a larger legacy than might otherwise be possible. The cost of life insurance may be significantly less than the proceeds of the policy paid to your beneficiaries when you die.
Donating a life insurance policy to a charity may enable you to make a larger gift than you otherwise could afford. Further, the government encourages charitable giving by providing tax advantages for certain charitable donations (the charity must be a qualified charity). This means that both you and the charity could benefit from your donation (though some charities may not accept a gift of life insurance for various reasons).
How Do Economists Measure Inflation, and Why Does it Matter to Investors?
The Federal Open Market Committee (FOMC) adjusts interest rates to help keep inflation near a 2% target. The FOMC’s preferred measure of inflation is the Price Index for Personal Consumption Expenditures (PCE), primarily because it covers a broad range of prices and picks up shifts in consumer behavior. The Fed also focuses on core inflation measures, which strip out volatile food and energy categories that are less likely to respond to monetary policy.
The typical American might be more familiar with the Consumer Price Index (CPI), which was the Fed’s favorite inflation gauge until 2012. The Consumer Price Index for All Urban Consumers (CPI-U) is used to determine cost-of-living adjustments for federal income taxes and Social Security.
The CPI only measures the prices that consumers actually pay for a fixed basket of goods, whereas the PCE tracks the prices of everything that is consumed, regardless of who pays. For example, the CPI includes a patient’s out-of-pocket costs for a doctor’s visit, while the PCE considers the total charge billed to insurance companies, the government, and the patient.
The PCE methodology uses current and past expenditures to adjust category weights, capturing consumers’ tendency to substitute less expensive goods for more expensive items. The weighting of CPI categories is only adjusted every two years, so the index does not respond quickly to changes in consumer spending habits, but it provides a good comparison of prices over time.
According to the CPI, inflation rose 2.1% in 2016 — right in line with the 20-year average of 2.13%.1 This level of inflation may not be a big strain on the family budget, but even moderate inflation can have a negative impact on the purchasing power of fixed-income investments. For example, a hypothetical investment earning 5% annually would have a “real return” of only 3% during a period of 2% annual inflation.
Of course, if inflation picks up speed, it could become a more pressing concern for consumers and investors.
U.S. Bureau of Labor Statistics, 2017 (data through December 2016)
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (member FINRA / SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The credit union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Prepared for Salal Investment Services by Broadridge Investor Communication Solutions, Inc. Copyright 2017.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. This communication is strictly intended for individuals residing in the state(s) of WA. No offers may be made or accepted from any resident outside the specific states referenced.