IRS rules stipulate that certain investors are required to take distributions from IRA and 401(k) plans.  The mandatory withdrawals are referred to as Required Minimum Distributions (RMDs).

The SECURE Act of December 2019 and the CARES Act of March 2020 both made changes to rules surrounding RMDs.  Understanding the process in light of these rule changes is important.

Failing to take your required minimum distribution by the deadline will result in a tax penalty. Planning ahead and understanding best practices for managing your RMDs can help you avoid headaches as well as hefty fines.

Following are some key things to know about RMDs and some best practices for managing this aspect of your retirement plan.

Who is Required to Take RMDs

The rules for RMDs changed with the passage of the SECURE Act in December of 2019.  This means the following individuals are required to take minimum distributions from an IRA or employer sponsored retirement plan like a 401(k).

• Plan account holders who turned 70 ½ prior to December 31, 2019.  Those born on or before June 30th, 1949 are subject to the old rules and must take RMDs.
• Plan account holders who turn 72 years old after December 31st, 2019.
• Non-spousal beneficiaries who inherited a retirement plan from an original owner who died on or before December 31st, 2019.

Retirement Plans Subject to RMDs

The rules for required distributions apply to:

• All tax-deferred IRA plans, such as Traditional, SEP, SIMPLE and SARSEP
• Qualified employer defined contribution plans including 401(k), 403(b), 457(b), TSP, and profit-sharing plans
• Roth participant accounts within a 401(k) plan
• A non-spousal Roth IRA inherited from an original owner who died on or before December 31, 2019.

A Roth IRA is not subject to Required Minimum Distributions during the lifetime of the initial account holder.

SECURE Act Changes for Inherited Plan

A non-spousal inherited retirement plan acquired from an original owner who passed on or before December 31, 2019 is subject to the old rules and Required Minimum Distributions must be taken from the account.

A non-spousal inherited retirement plan acquired from an original owner who passed after December 31st, 2019 is subject to new rules implemented by the SECURE Act.  Rather than take minimum distributions each year, the entire account must be distributed by the end of the 10th year following the original account holder’s death.  Distributions can take place with any amount or frequency during the 10-year period, so long as the full account is ultimately distributed by the end of the period.

CARES Act Changes for the 2020 Tax Year

To protect retirement savers from having to take distributions during the economic downturn created by the COVID-19 pandemic, congress suspended the requirement to take Required Minimum Distributions in the 2020 tax year as part of the CARES Act.

All account holders who may have taken a RMD prior to the passage of the CARES Act in March were provided the opportunity to treat the distribution as a rollover and deposit the funds into a qualified retirement plan no later than August 31st, 2020.  Such rollovers were exempted from the one indirect rollover per 12-month rule that normally applies.

Investors who may have taken a RMD and not rolled those funds back into a retirement plan before August 31st, may still have an opportunity to do so.  If you were impacted by Coronavirus and therefore eligible to take a Coronavirus Related Distribution (CRD) from a retirement plan, you can treat your earlier RMD as a CRD.  This gives you until the end of 2020 to effectively treat the re-deposit of those funds into a retirement plan as a non-taxable rollover.  Speak with your licensed CPA or tax advisor to gain full understanding of this strategy before proceeding.

Account Valuation

The calculation for Required Minimum Distributions is based on the account value on December 31st of the year prior to the distribution.  For example, the December 31, 2020 value will be used to determine the amount one must distribute in 2021.

In a self-directed IRA or Solo 401(k), it is your responsibility to determine and report on the fair market value of your account each year.  While in a conventional stock-market based IRA the account custodian can look up your holdings on a public exchange and calculate the value, that is not possible when your IRA is invested in non-traditional assets such as real estate.

With a checkbook IRA, this means reporting the fair market value of your IRA-owned LLC or trust entity to the custodian as of December 31st.  The value is a balance sheet number, representing the total of all holdings within the entity such as real estate, stocks, notes, private placements, cash, etc.

Work with your IRA custodian to understand the specific procedure required to report valuation.  The deadline for reporting is usually mid-January so the custodian can have time to include the year-end value as part of their annual reporting to the IRS on form 5498.

Some custodians will want a licensed 3rd party such as a CPA, attorney, or appraiser to sign off on the summary valuation for accounts subject to Required Minimum Distributions.

Other IRA custodians will accept a full listing of individual assets and their values for investments within the checkbook entity in place of a 3rd party certification.

Preparing for end of year valuation can take time.  Especially if there is a need for formal valuation documents or appraisals.  Be sure you understand the requirements of your IRA custodian and don’t wait until the last moment.

With a Solo 401(k), you are the plan administrator and responsible for maintaining records regarding plan valuation.  If your total plan value is less than $250,000, no formal reporting is done, but you will need to have records demonstrating plan holdings and values.  If the plan value is over $250,000, then you will be reporting on IRS form 5500-EZ and end-of-year valuation will be part of that process.

In all cases, you will want to have evidence to support the valuation you have provided should the IRS question the matter.

Sourcing RMDs

Each retirement plan you hold that is subject to RMDs will perform its own distinct calculation to determine the amount that must be distributed.

If you have more than one IRA, you can choose which account or accounts you take the distributions from. This grouping of accounts is not available with defined contribution plans like 401(k)s, which must be directly distributed from based on the amount calculated for each account.

Assume you have two IRAs; one that requires a $6,000 RMD and another that requires a $4,000 RMD.  You have met your obligation so long as you take a total of $10,000 in some fashion from one or both accounts.  This allows you to take your distributions from the account where you have greater liquidity or where selling assets to create liquidity is more favorable.

Taking RMDs from Your Plan

To take a distribution from a Checkbook IRA a two-step process is required.  You musty first send cash from your IRA owned entity to the IRA account custodian.  This action represents a liquidation of the IRA’s investment into the entity, much like selling shares of a stock or fund in a conventional IRA.

Once funds have been deposited to the IRA, you can then ask the IRA custodian to issue and report on the distribution to you.

Never issue funds from your IRA-owned LLC or trust directly to yourself.  This breaks the proper chain of reporting and could have severe tax consequences.

Taking an IRA distribution can take 2-3 weeks depending on what method is used to move funds (check, wire, etc.).  December is also the busiest time of the year for IRA custodians, so processing of transactions can tend to take a bit longer.  We strongly recommend you begin your distribution process no later than December 1st to ensure completion by the December 31st deadline.

With a Solo 401(k) plan, you are the plan administrator and can simply issue funds from your plan account to yourself to facilitate a distribution.  You must issue such distributions on or before December 31st.  You then need to report the distribution using IRS form 1099-R and include that amount on your personal tax return.

Roth Conversions

For well-off investors who may not need to take distributions from their retirement plan, performing a Roth IRA conversion can eliminate the RMD requirement on converted funds.

Since the Roth conversion will also have a tax impact, most older account holders will not see a net benefit from such a move in their lifetime.  The benefit of this move will be the ability to pass tax-free Roth wealth to your heirs.  Be sure to consult with your tax advisor before pursuing this strategy.

As a reminder, a Roth 401(k) is not exempt from RMDs.  It may make sense to rollover funds held in a Roth 401(k) to a separate Roth IRA to eliminate the need for distributions.

In Summary

For certain IRA and 401(k) account holders, Required Minimum Distributions are a part of life.  It is necessary to plan ahead for these events to ensure you have proper reporting for your plan and take your required distributions by the mandated deadline, as failure on either point can have adverse consequences.  Working with your licensed tax advisor to plan your strategies surrounding RMDs is highly recommended.