Retirement Distributions

You’ve reached retirement age. You’re ready to go and pursue your hobbies, travel, whatever it is, and you need some money. So, let’s talk about taking distributions from your IRA accounts, and let’s split it up between age 59 1/2, till the time you reach required minimum distribution age, and then after required minimum distribution age.

The SECURE I Act and the SECURE II Act that we talked about back in lesson 1 made some significant changes to distributions from IRAs, mainly the age you have to start taking them. The second changes it did deals with inherited IRAs and how that money needs to be taken by your heirs. So, let’s talk first about Roth and Roth 401Ks because the treatment is exactly the same for IRAs and 401Ks, except that there’s one exception, but that’s plan specific, and we’ll talk about that in a minute.

So, before you could take a distribution from any kind of Roth account, the account must be open, open and funded. So, it doesn’t matter, it’s got to have a little bit money in it the first year for five years before you could take distribution one. Otherwise, there’s a penalty. The amount of increase in value is taxable, plus there’s a penalty.

Secondly, you must be at least 59 1/2 to avoid the 10% early distribution penalty from a Roth account. Everybody thinks Roth money comes out tax free. It is if you do it right, but if you do it wrong, you’re really not in a good place. The other thing I must mention at this point, and those are all the rules that you need to be concerned about, do it right, there’s no tax, are two things, and here’s the two, or really one thing to remember.

Roth taxability of distributions has come up in Congress to be changed and make it somewhat taxable. Whether this will happen or not, who knows? But, at this point, they are not taxable. It’s been proposed a couple of times in Congress over the last 10 years. It’s never passed, it’s never stuck, but as we all know, no one can predict what’s going to go on in Washington, D.C. And so just keep that in mind with your Roth IRAs, and if you see that coming, you might want to think about taking your money out. Couple of things to also remember. Roth IRAs and Roth 401ks, get left to your heirs without tax, so the money can be taken out without tax. That’s a great way to get money to your heirs without [00:03:00] tax.

There are a couple rules. If you’re the spouse of the deceased person, so we’re going to call him the owner of the account, you still have to abide by the five-year rule. You still have to abide by the 59 ½ year rule, but if you’re the spouse, you treat that account as if it was your own. So same thing.

If you’re not the spouse, there’s more rules. If you’re not the minor child of the deceased, then you must distribute the account entirely within 10 years. If you are the minor child of the deceased, meaning that you’re, under 18, you may take distributions based on your, the child’s, life expectancy until age 18 and it can be increased until age 26, but then it must all be taken. So, they’re a little bit complex, especially for minor children, and there are new regulations, and by new regulations I mean that they came out in July of 2024, that cover this area. So, there’s something you want to make sure that you’re getting good sound advice and the latest advice.

Moving on to our traditional 401ks and IRAs. Money coming out of those accounts is taxable. It’s taxable as ordinary income. Now we’ve talked about making sure that those accounts have a basis. If you’ve made after tax contributions to those accounts, that creates basis in those accounts. That portion of those accounts is not taxable, and it’s a fraction, so you need to figure it out every year.

So, prior to the two SECURE Acts, distributions had to start at age 70 and a half. That was a hard and fast rule. SECURE 1.0 increased that age to 72 years. If you turned 72 prior to 2023 and in 2023 it became 73. In 2033, it increases to 75. So, if you’re kind of in that age gap grade where you turned 73 and then don’t turn 75 before 2023, you have to start distributions. And once you start. You cannot stop, so it’s, it’s a hard starting. Your required minimum distribution is a formula. It is the fair market value of the account at the end of the year in total, times an age factor table that the IRS publishes and updates on a regular basis.

So, you find your age for the year in question, you take the fair market value of all your accounts. And that’s the money you need to withdraw. Now, the question is, is do you need to take that over each account? No, you can choose to take it all out of one account. Say for some reason you have a small IRA someplace, but it’s enough to cover your RMD for this year.

You may want to take all of it out of that account, close that account, and not have to be bothered with it. That’s one example. Or you can choose to take it all out of your biggest account, or maybe the one that’s not performing the best. It doesn’t matter, you don’t have to take it across all your retirement accounts.

You can take it all from one in any year. Now, let’s go back to our old friend Form 8606 that you’ve been filing all along in your 1040 and as you’ve contributed money to your traditional IRA. After tax money. So, you’ve got your required minimum distribution, you’ve taken it.  

Again, that’s reported on our friend Form 8606, and that can save you money. What happens if you haven’t filed that form? You’ve put money in over the years, you don’t really know how much because I don’t know about you, but my record keeping’s not that good. I haven’t been keeping good records since I was 20, and you really don’t know.

Well, here’s the catch. You have to prove it to the IRS if you come up with a number and proving that to the IRS could be hard. You need to show proof that you’ve contributed to that each year. So, what would be your proof? The tax reporting every year or a form of the statement, but do you want to go through all that work?

And do you have that work? Before electronic statements, a lot of that was in paper, and if you’re of a certain age, some of it is still in paper. So, it’s a lot of paperwork, and it may not be very well constructed so that you could prove it to the IRS. Would they audit it? It depends on how much money it is, and it really is depending on what your tax return looks like.

So, that’s something to be aware of. I pushed this form, and I, again, I said early on that I thought it was a very underutilized form. This is why. It does come back to help you. So, when you inherit a traditional IRA, the rules are similar, but not the same as a Roth IRA. First of all, there’s no five-year time limit on the account. You can start drawing money out. And distributions are taxable at ordinary income rates, just like wages.

And there’s some rules. If you’re the spouse of the owner of the original account or the deceased, you can treat the account as if it is your own. You may combine the account with yours and then for ease of management and calculate the RMD like it was over your lifetime.

There’s a couple of rules with that. The spouse that inherits has age restrictions, but it’s their age you use, not the deceased. But if you inherited an IRA from someone other than your spouse, the Secure II Act changed these rules. This is for people dying after 2020, so anything before that, the rules again are different. Let’s start at the beginning.

So, if you are not the minor or your child of the deceased, so the owner of the account dies, you’re not his child and you’re not his minor, so you could be a grandchild, you could be sister, brother.

Any other kind of relation, you could be best friends. An inherited an IRA account. It doesn’t matter who you leave it to. If you’re not a minor child, you have 10 years to withdraw all that money from the account. You can do some in year 1, some in year 10, doesn’t matter by the end of the 10th year after death, that needs to be fully distributed.

If you are a minor child of the deceased, you can postpone your distributions to age 18 or age 26 and there’s rules for that gap in between, involving full time student and different all sorts of rules. But if you have a minor child, then the rules which the IRS has just clarified, you need to take a distribution annually based on the child’s age until they reach the age of maturity either 18 or 26 and then they have until 10 years to withdraw the rest of it.

Now, this takes some tax planning. Step back from it. First of all, if you have a minor child, they are subject to tax. So, you need to be aware if you’re taking an IRA distribution or have to take an IRA distribution for this minor child, they’re going to need a tax return or reporting on your tax return.

Secondly, you may want to time this. There may come a time under the current tax structure where they’re of no value to the parents as an exemption because there’s certain rules concerning that and once you get it to a certain level of income, they’re not valuable. So, they might be better filing on their own, filing a single, and paying a relatively low rate of ordinary income tax on this because it’s likely to be their only income if they’re in college or their income is insignificant.

So, you have to be careful because you may not want to wait too long to take a big bump on this until they get that first job. They get that first job and all of a sudden you boosted their income bracket. significantly. So, you need to look at that and plan accordingly. It’s not all crystal clear.

Likewise, on your distributions and distributions that you have to take, if you inherit an IRA and you’ve not yet reached your required minimum distribution age, so say your parent dies, they leave you their IRA because their spouse is dead, you now have 10 years to take it, and you haven’t reached your age to take your retirement account at age 73.

You might want to bunch those up before you reach age 73 to keep your bracket low if you’re still not working. Now, there’s one other option to keep this all from being taxable. Each year you can contribute part of your required minimum distribution to a charity. A public charity of any type, so it can be a school, any of the major charities such as the Heart Association, the Alzheimer’s Association, whatever is close to your heart.

So, you can do up to $105,000 in 2024. This is a number that they are starting to index in 2024. A couple things to be aware of. That money must never touch you, so you need to go to your custodian that holds Your IRA, and say, I want to give a X amount of dollars to this charity. Will you, as part of my RMD, please write the check to the charity and send it to them?

So, it’s not they write the check to you, and you write a check to the charity or send it electronically, however you choose to do it. No, it must go from the fiduciary of your account, the holder of your account, directly to the charity. The brokerage firms and the major banks will all do this.

There’s really no one that won’t do this. They do have some requirements, however. They do require it to be a qualified charity, which is the rule. The IRS requires it to be not taxable. And the second thing they require is they have a dollar limit. They don’t want to do it for $50. They want to make it meaningful, so most of them will do it for, depends on the firm, $250, $500.

You don’t have to give the entire $105,000. You can take part of the distribution and give part of the distribution. You don’t have to take it all to one place. You could do it to ten places. It doesn’t matter. So that’s something to consider, that you will still get a 1099R reporting that amount and it still does get reported on your tax return.

It’s just not taxable to you. That’s something to consider if you have any money to give away or have that inclination to give some money.

IRS Publications: 1040, 8606, 590A and 590B