One of the more confusing aspects of an individual retirement account is the concept of required minimum distributions. Required minimum distributions (or “RMDs”) are distributions or withdrawals that certain IRA account holders must make every year once they reach age 70½.
If you find yourself in a situation where you need to begin taking these RMDs next year, you may wish to start planning now for how they’re going to affect you, and how you’re going to respond. Here are some steps to consider if you need to take these distributions from your IRA next year.
Understand the General Rules.
The starting point should be to understand exactly what the rules regarding RMDs require. First of all, these distributions only apply to traditional IRAs – Roth accounts are exempted. Second, the amount of each annual required minimum distribution is calculated every year, based on your age and the balance in your traditional IRA. Finally, the annual RMD amount is only a minimum; you’re free to withdraw more than that amount.
Understand That Planning May be Necessary.
Keep in mind that the rules on RMDs apply whether or not you’re ready to liquidate any of the assets in your account, whether or not doing so would cause a financial burden, or whether you even need the money to pay for your retirement. This matters a great deal if you’re going to be forced to liquidate investments that you believe are temporarily undervalued (and you’d rather not sell). Furthermore, the RMD rules can be problematic if your traditional IRA is a self-directed IRA, in which case you may hold a portion of your account – perhaps a sizable portion – in relatively illiquid assets.
In fact, liquidating real estate investments involves particular challenges. You can’t easily sell a partial interest in order to liquidate a portion of your interest; selling your real estate is generally an “all or nothing” proposition. Consider how difficult it may be to sell a piece of property if you have a long-term tenant that’s currently renting it. And consider how your portfolio would suffer if the local real estate market is temporarily weak but you’re forced to sell.
Taking a distribution from your self-directed IRA that you haven’t adequately planned for may therefore come at a high cost.
Consider Converting to a Roth Self-Directed IRA.
We mentioned above that Roth IRAs are not subject to the rules on required minimum distributions. Fortunately, if your IRA is now structured as a traditional account you’re not stuck with eventually having to deal with RMDs. The tax rules permit you to convert a traditional IRA into a Roth IRA, but you’ll be responsible for an immediate tax bill based on the amount of the conversion. Making this conversion frees you from the potentially costly RMD rules.
In trying to decide how to best deal with the rules on required minimum distributions from your traditional individual retirement account, you may wish to consult with an experienced IRA custodian such as Quest Trust Company.