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Tax Advice for the President-Elect

Trump has an important RMD decision to make for himself this year and could provide some much-needed tax reform for the rest of us, writes columnist Natalie Choate.

Natalie Choate, 12/09/2016

Dear President-Elect Trump,

Here is some unsolicited advice regarding retirement benefits tax planning--for you and for the nation.

For You Personally
This is the year in which you won the presidential election, but even more important, it is the year in which you are reaching age 70 1/2. So 2016 is the first "Distribution Year" (year for which a distribution is required) for your IRA.

You have important choices to make this year: Who will be your cabinet members, for example, but also whether to take your 2016 RMD this year (2016) or postpone it until April 1 of 2017 (your age 71 1/2 year). This first-RMD-year (2016) is the only year you will have any choice on that. Starting with next year's RMD, every year's RMD must be paid in that calendar year.

I recommend that you first consider using one or more qualified charitable distributions (QCDs) to satisfy your 2016 RMD if that is consistent with your charitable giving plans. Your 70th birthday was on June 14, 2016, so you are eligible to make a QCD anytime on or after Dec. 14, 2016. See my November 2016 column for QCD details.

To the extent your 2016 RMD is not fulfilled with QCDs, I recommend that you postpone taking it until 2017. That's because I presume you will be in a lower tax bracket in 2017. I'm guessing that your salary next year as U.S. president, $400,000, is less than what you got paid by your businesses this year. Also tax-law changes (proposed by you!) appear likely to lower rates next year. So postponing the 2016 RMD to 2017 seems like a good bet.

If you haven't done so already, I recommend naming your wife Melania as sole beneficiary of your IRA. Most people your age (turning age 70 in 2016) have to withdraw 1/27.4th (3.65%) of their Dec. 31, 2015, account balance for the 2016 distribution year. On the other hand, if you name Melania (turning age 46 in 2016) as sole beneficiary of your IRA for the entire year, you would be entitled to use the joint life expectancy of yourself and your more-than-10-years-younger spouse to compute your RMD. You would be required to withdraw only 1.38.6th (2.59%) of your Dec. 31, 2015, account balance. For a $1 million IRA, that would be a difference of $10,589 ($36,496 vs. $25,907).

For the Rest of Us--Much Needed Tax Reform
For a bold tax reform idea, I recommend you initiate repeal of § 72(t) of the Internal Revenue Code. That's the section that imposes an extra 10% tax on retirement plan distributions received prior to age 59 1/2. Repealing it should cause your popularity to soar with young people.

The 10% "premature distributions penalty" is intended to discourage people from withdrawing from their retirement plans prior to reaching retirement age. The theory is, the tax code gives you tax breaks to save for retirement and, by gosh, you'd better use these plans for retirement or else.

But does the tax actually work to discourage people from prematurely cashing out retirement plans? We'll never know because there's no way to test that. Meanwhile, one can speculate that it is equally effective at discouraging young people from saving for retirement in the first place because they will not be able to get their own money back without penalty, no matter how much they need it, until age 59 1/2.

The tax is festooned with 13(!) exceptions. Apparently, it makes Congress feel good to dole out nitpicking exceptions for certain favored types of problems. The Tax Code exempts from the tax, for example, an unemployed person who uses the money to pay her health insurance premium. But what if that desperate unemployed person uses the withdrawal to pay her mortgage or her family's food bill? She has to pay the 10% tax, because there is no "hardship exception" as such.

You get the ridiculous situation of a young person receiving a tax-code-defined "hardship distribution" from a 401(k) plan, and then having to pay 10% of the hardship distribution to the U.S. Treasury.

The 13 exceptions make this tax about as complicated as anything in the Tax Code. For example, some exceptions apply only to IRAs, some only to qualified plans, and some to both types. I used to say only the uninformed poor wound up paying this tax, because tax-savvy and/or wealthy people could figure out a way around it (or hire someone to do so). I was proven wrong when a CPA studying for his Ph.D. got stuck paying the tax because he didn't know the educational expenses-exception applies only to IRA distributions, not 401(k) distributions.

But it's true that the tax falls mostly on the poor and the desperate. People who have lost their jobs and are running short of food and mortgage money have to tap their retirement plans. They may not even owe income tax on the withdrawal because their absence of income puts them in the 0% income tax bracket. But they still have to pay the 10% penalty!

Win the younger generation to your side forever--repeal § 72(t)! 

Closing Note on Your Personal Situation
I showed a draft of this column to a financial reporter who told me that (according to your financial disclosure forms) you don't even own an IRA. If she's right about that, then I now understand why you needed to apply for a new four-year job at age 70: You must have forgotten to save for retirement!

Where to read more: For more on the 10% penalty applicable to distributions before age 59 1/2, including all rules, examples, and full citations for the assertions above, see Chapter 9 of the author's book Life and Death Planning for Retirement Benefits (7th ed. 2011) or the expanded version of this article posted at http://www.ataxplan.com.

Natalie Choate will be speaking at a location near you if you live in: Little Rock, Ark. (Feb. 16, 2017); Manhattan Beach, Calif. (April 28, 2017); Asheville, N.C. (May 4, 2017); Augusta, Maine (May 5, 2017); Waltham, Mass. (June 2, 2017); or Indianapolis (Sept. 13, 2017). See all of Natalie's upcoming speaking events at http://www.ataxplan.com/seminars/schedule.cfm.

Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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