This podcast was recorded on July 26, 2016.
Alison Southwick: Time for "Answers, Answers." Required minimum distributions aren't a thrilling topic, but ...
Robert Brokamp: No, they're not ...
Southwick: ... what if I sing it in an enthusiastic way?
Brokamp: Oh, that would be great. Please do.
Southwick: Required minimum dis-tri-bu-tions! Yes! Get some! Did that help?
Brokamp: That's going to be the highlight of the next five minutes of this show.
Southwick: All right. We have a couple of questions you want to tackle, yeah?
Southwick: The first one comes from Rollo: "My question has to do with traditional IRA" -- required minimum with-drawals! "Do I have to convert to cash to make the withdrawal? Can I move my stocks directly to a Roth or another account?"
And then the second question comes from Linda: "When you turn 70 1/2, do you need to withdraw all of the required amount at one time, or can it be a monthly withdrawal? Does it apply to all IRAs, individually, or combined totals? Are there any clearly written instructions for this?"
Brokamp: Well, Alison, as you pointed out, this is not a thrilling topic, but it is important, because not only do required minimum distributions dictate when you have to take money out of your retirement accounts; they also relate to whether you can continue to put money in. It's actually kind of complicated, and each retirement account is different, so let's go through the roll call here. First of all, traditional IRAs. You have to start taking money out at age 70 1/2.
Southwick: Take a step back. Why do I have to?
Brokamp: Basically, I think what Uncle Sam is saying is we have deferred the taxation on this account, but we don't want to defer it forever. We'd like you to take the money out so we can get our taxes at some point. I'm guessing that's why.
Brokamp: In other words, you have to take the money out even if you don't need it, and even if you're still working. And that also means even if you're still working, you can't contribute to a traditional IRA. A Roth IRA is different. You don't need to take the money out, and even if you're 80, 85, 90, as long as you're still working, you can contribute to the Roth IRA.
Retirement accounts from work, like a 401(k), are a little different. As long as you're working, you don't have to take the money out, whether it's a Roth or traditional. Once you stop, you have to start taking the money out, even if it's a Roth 401(k).
Brokamp: But you can bypass that by just transferring it over to a Roth IRA. Then you don't have to worry about the required minimum distributions.
Southwick: Ugh! It is confusing.
Brokamp: I know, it is confusing. And then there are the IRAs that you inherit. If you are the spouse of the person and you inherit it, you can basically make it your own IRA. If you are not the spouse -- maybe you're a kid, grandkid -- you actually have to start taking out required minimum distributions even if you're, like, 5 years old. You have to start taking the money out. So this doesn't just apply to people who are age 70 1/2.
There are some proposed rules of changing this, so that in inherited IRAs, you have to take the money out within five years, but so far right now the rules are you only have to take a little bit out each year and then let the rest grow.
OK, so those are the rules of the different accounts, but to answer some of these other questions, first of all, if you have multiple IRAs, you can take the required minimum distribution out of just one of the IRAs. If you have multiple retirement accounts -- 401(k)s -- you have to take it out from each individual account.
However, it does not have to be in cash, and this is what Rollo was asking about. You can only put cash in a retirement account, but you can actually take stocks out of the account. It's called an in-kind distribution. Why would you want to do that?
Well, maybe you don't need the money. It's invested in a stock that you don't want to sell. So instead of taking the cash out, you just take out your Apple stock or whatever stock you own. You could, of course, just sell it and then buy it outside of it, but you save yourself a couple of commissions by doing it that way. You still have to pay taxes on it.
Another question Rollo had was, can you take the required minimum distribution and just put it into a Roth, and the quick answer is no. That's considered a conversion, and a conversion does not satisfy the requirement of required minimum distribution. However, if you have a big, old, fat, traditional IRA, and you know you're going to be paying big required distributions, by starting to convert some of that money to Roth earlier, you will be reducing your future required minimum distributions, because that traditional account will be smaller.
Finally, you may be asking where you figure out your required minimum distribution. It's actually based on a factor based on your age. For example, if you are 70 ...
Southwick: And a half ...
Brokamp: ... and a half ...
Southwick: ... such as Linda ...
Brokamp: ...such as Linda, you go to this exciting IRS table. You take the value of your account from Dec. 31 of the previous year and you divide it by, if you're 70, 27.4. So you're taking out a little less than 4% of the account each year. And that number grows as you get older, so the IRS has a table all the way up until you're 115 or over. If you make it that far, your factor is 1.9, so you actually have to take out more than half of your account ...
Brokamp: ... each year, if you make it that far. Once you calculate the amount you have to withdraw, you can do it all at once, or you can spread it out over the course of the year, maybe monthly, but just make sure you have it all taken out by Dec. 31 of that year.
The good thing is you probably don't have to look that up. If you have a good account provider, a good brokerage, or a good financial advisor, they will help you with this. They might even do it for you and then send you a letter in the mail. Just make sure that you do it, because if you don't, the penalty is 50% of the amount that you were supposed to take out. If you forget, you can file a waiver. Send a nice letter to the IRS. They might give you a break one time. But you definitely have to do it. If you really want to read the nitty-gritty, you can find it all in the exciting IRS Publication 590-B.
Southwick: Ooh, 590-B.
Brokamp: Can you sing that?
Southwick: 590-B. I don't know.
Brokamp: That was good.
Southwick: Should I do the whole ... IRS Publication 590-B?
Brokamp: Oh, yeah.
Southwick: We're going to make this fun, damn it.
Brokamp: There you go.
Southwick: If I have to pull this show over. I will do that. Thanks, Bro. That was ...
Southwick: That was rough. I mean, there's just a lot there. A lot to unpack.
Brokamp: Well, it demonstrates how complicated it is, so you definitely have to learn a little bit more. But the penalty is steep. There are very few IRS penalties that are 50% of something, so definitely make sure you know what you're doing.