Avoid These RMD Traps

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. It's the fourth quarter and that means it's required minimum distributions season. Joining me to share some tips and traps for RMD taking is retirement expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Thanks, Christine.

Benz: Well, it's the fourth quarter and it's required minimum distributions season. I know a lot of our viewers are subject to RMDs. I wanted to walk through some of the rules and also some of the traps that you see people falling into. Let's start with just, kind of, the basics of RMDs--which accounts are subject to required minimum distributions and who is subject to RMDs.

Slott: Well, RMDs, required minimum distributions, most seniors know them well. That's the time after age 70 1/2 they're forced to take the money out, whether they want to or not and add to their tax bill. IRAs are subject to RMDs, so are most company plans; Roth IRAs, your own, are not.

Benz: That's the one exception. Roth 401(k) though sometimes …

Slott: Are, because they are part of a 401(k). But there's an easy way around that. If you are approaching age 70 and you're still working, you have a Roth 401(k), just move it over to your own Roth IRA before the year you turn 70 1/2 and that will stop that. Because now that it's in your own Roth IRA, there are no required minimum distributions if your plan lets you do that.

Benz: One cohort who potentially is not subject to RMDs is the people who are still working in retirement at 70 1/2, and they have those company retirement plan assets. Those assets are not subject to RMDs, correct?

Slott: Maybe. That's where you see lots of mistakes. This is one of those areas where, I always say the law of the plan is the law of the land. This is one of those areas, as complicated and technical as all these tax rules around IRAs and plans are, the tax rules themselves are actually more liberal than what the plans have to allow. They don't have to allow it. Now, lots of plans allow what we call this "still working" exception, which means, if you are still working after 70 1/2, you can delay--in the plan, if they allow it, the tax rules absolutely allow it--if they allow it, you can delay your required minimum distributions from that company's plan, the company you are still working for, until you retire.

But here is the mistake. First, not everybody qualifies. Basically, if you are self-employed, you can't do this in your own plan. There's what's called a 5% rule. If you own more than 5% of the stock, as most self-employed people do, you can't do it.

Benz: Okay.

Slott: But a regular employee from big companies doesn't own 5% of IBM or something like that. But here is the mistake. People that this applies to, they think it applies everywhere. The exception or the deferral only applies to the plan of the company you are still actively working for. If you have other 401(k)s, you still must take from those. This rule never applies to IRAs. You still must take from those. Remember, with a required minimum distribution, if you are short or don't take it, it's a 50% penalty on the amount you should have taken but didn't. So, yes, you might qualify for this exception but it's only in that company's plan, no other plans.

Benz: Let's talk about the calculation. It's fairly straightforward. You look at the right table and calculate how much you need to take out.

Slott: I'm laughing because you threw in, to assume you looked at the right table.

Benz: Let's start there. Because there are a couple of tables that one could look at. You say that you have encountered people who have made some calculation errors. Let's talk about how to keep yourself straight in terms of taking out the right amount.

Slott: Well, it is kind of easy. IRS gives you three tables; two could apply to you, most people just one. It's the Uniform Lifetime table. You can get it in IRS publication 590-B and they have all three tables. Now, for an odd situation, or maybe not that odd, if your spouse is your sole beneficiary for the entire year and that spouse is more than 10 years younger, you can go to the expanded joint table and get a little better break. That's a separate table. But other than that exception, everybody uses the Uniform Lifetime table. The Single Life table, that third table, is only for beneficiaries. Never use that.

Benz: Say I have multiple IRAs, which is very common, I have a lot of accounts, do I total them all up and then put them through one of those tables? How does that work?

Slott: Yes. This is where things get a little …

Benz: The aggregation.

Slott: Yeah, the aggregation get a little confusing. IRAs have what's called an aggregation rule, which means, just as you said, people have a bunch of IRAs. Under the tax law, you only have one IRA. Even if you have 10, it's all considered one. Under the tax rules, you can take your required minimum distribution. First, you figure out the RMD from all of your IRAs and whatever that total is, you can take it from any one or a combination of those IRAs. But you can't take it, say, from a 401(k) or a 403(b), you can't use another account to satisfy the RMD from a different type of account.

Benz: Let's talk about some of the other traps that can crop up in the RMD space. One thing I sometimes hear from our Morningstar.com viewers and readers is, I have this RMD and I don't need it, so I'm going to put it into a Roth IRA.

Slott: Yeah, it's up there with the top questions. You know why it's a good question? Because it's logical, but the tax law isn't logical. I have had people that tell me, I took the money, I paid the tax, isn't that all they want? Why can't I put it in a Roth? It's already bought and paid for. Because you can't; because the tax law says, at rollovers--required minimum distributions cannot be rolled over; otherwise, the money would never get out. And a conversion is considered a rollover. The RMD must first be taken and that money cannot be converted. But then you can convert other money once the RMD is satisfied, and if you want, the money you took out that you can't covert, you can use that to pay the tax on other monies you can covert.

Benz: But I could potentially take out my RMD and assuming I'm still working, I could fund a Roth IRA, that's right, right?

Slott: Right, because there's no age limit on who can contribute to a Roth IRA, but there is an income limit. So, you have to look at that.

Benz: Even if I'm not working but my spouse is working, we could make an IRA contribution up to …

Slott: Right, but the spouse has to qualify other than having earned income.

Benz: One thing that you say is going to be really important for a lot of retirees this year is what's called a qualified charitable distribution. Let's talk about that and how RMD-subject retirees can take advantage of that maneuver and why they may want to consider it.

Slott: Well, every person that gives to charity should only be doing it this way. The only thing bad about the qualified charitable distribution or QCD is that it's not available to everyone. It's only available to IRA owners or beneficiaries who are 70 1/2 or older. If you are 70 1/2 or older, you have an IRA, you are taking your RMDs; if you also give to charity, what you should do is do the QCD, which is a direct transfer from your IRA to the charity.

What that does, it's excluded from income, and the amount you give to charity goes toward satisfying your RMD and you can do, if you want to, up to $100,000 per person, not per IRA, per person, per year. You are excluding that income. That's the same as getting a deduction, but it's better than a deduction, because you are reducing your adjusted gross income, which is a key number on the tax return. Now, you don't also get the charitable deduction because that would be double dipping.

Benz: Let's talk about what about 2018 and the years that follow make the QCD particularly attractive. It's that many fewer people will be itemizing their deductions?

Slott: That's right. You may be giving to charity and you will realize when you do your tax return, I'm not even getting the deduction, because most people under the new tax law for 2018 will be using the new higher standard deductions. They won't get the benefit of the charitable deduction. If you use the QCD, you get the new higher standard deduction and in effect, the charitable deduction; now, I say, in effect, because you are not getting a deduction, but reducing or excluding it from income is the same as a deduction. You get that plus the big standard deduction. Everybody should be using it who qualifies.

Benz: If you are charitably inclined at all. And you might hear $100,000 and think, oh, I need to be a high roller. If I'm writing a $200 check, I should consider …

Slott: But you know the question we get: Somebody has a required minimum distribution of $5,000, let's say, but they normally give $7,000 to charity. You can give more than the RMD. The first $5,000 satisfies the RMD and the other $2,000 is also excluded.

Benz: Ed, valuable advice. Thanks so much for being here.

Slott: Thanks.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.