Background. In general, the first distribution year is the year in which the IRA or qualified plan account owner attains age 70- 1/2. The taxpayer may postpone the first year’s RMD until the second distribution year (i.e., make the first-year RMD by April 1 of the second year). However, taking advantage of the three-month “grace period” for the first distribution year’s RMD does not absolve the taxpayer from making an RMD for the second distribution year.
HATS illustration 1: Betty, a widow, celebrated her 70th birthday on Mar. 1, 2014, and thus will attain age 70- 1/2 this year. She is the owner of a traditional IRA that had a value of $1,370,000 on Dec. 31, 2013. Her RMD for 2014, the first distribution year, is $50,000 ($1,370,000 divided by 27.4, the factor from the Uniform Table, for an individual who is 70, Betty’s age at her birthday in 2014). Betty may delay taking this distribution until as late as Apr. 1, 2015, but even if she does, she must still take an RMD for 2015. Assume that Betty does not take the first distribution in 2014, and the value of her IRA is $1,391,250 on Dec. 31, 2014. Her RMD for 2015 will be $52,500 ($1,391,250 divided by 26.5, the factor from the Uniform Table for an individual who is 71). By delaying taking her first distribution until 2015, Betty must take total distributions of $102,500 in that year ($50,000 for the 2014 required distributions, and $52,500 for the 2015 required distribution).
Delaying taking the first year’s RMD until the second distribution year could have one or more of the following effects:
(1) All or part of the first distribution may be taxed at a higher rate than it would be if it was distributed in the first year.
(2) The resulting increase in the distributee’s adjusted gross income for the second distribution year may cause a reduction in deductions and/or credits subject to an AGI floor, such as:
… the deduction for medical expenses;
… total itemized deductions;
… the deduction for personal exemptions; and
… the amount of non-passive income that can be offset by passive losses from an active participation rental real estate activity.
(3) The large distribution may cause the taxpayer’s modified adjusted gross income (MAGI) to exceed the threshold amount that triggers the 3.8% surtax on net investment income
(4) More of a lower-income distributee’s social security benefits may be subject to tax.
When it may be advisable to delay taking the first distribution until the second distribution year. There are situations when it will be advisable for an individual who attains age 70- 1/2 in 2014 to delay taking the first (2014) distribution from a traditional IRA or a qualified plan until 2015. Here are key examples:
(A) The distributee expects to be in a lower tax bracket in 2015. This could result from the distributee having lower taxable income from other sources in 2015.
(B) Taking the first distribution in 2014 will cause the distributee’s modified adjusted gross income (MAGI) to exceed the threshold amount that triggers the 3.8% surtax on net investment income, but deferring the distribution until next year will not have the same effect because the distributee’s income from other sources will be lower. The threshold amount of MAGI is $250,000 for joint filers or surviving spouses, $125,000 for marrieds filing a separate return, and $200,000 in any other case.
(C) The distributee expects that taking two distributions in 2015 won’t cause any part of the total distribution to be taxed at a higher rate than it would be taxed at if the distributions were taken in 2014 and 2015. By deferring the 2014 distribution to 2015, the distributee can continue to earn tax-deferred income on the first distribution for up to an additional three months.
(D) If the distributee expects to have less income from other sources in 2015, deferring the 2014 distribution to that year may enable the distributee to avoid or minimize AGI limitations in 2014 without causing any increase in those limitations in 2015.
For additional information on these issues or to discuss your personal tax situation, please call us at (630) 544-5340.