Fair Market Valuations in Your IRA

Fair Market Valuations (FMVs) are an annual requirement set forth by the IRS to determine the value of the assets in your IRA. An FMV is calculated based on the current price of comparable assets, and how much a knowledgeable and willing buyer would reasonably pay for that asset if it were sold that day, no matter if it’s a real estate property, an LLC, or a private placement. Some Retirement account providers are required to report the FMV of accounts as of December 31st each year to the IRS and must provide the account holder with the same information by January 31st the following month.

FMVs are typically used to determine what the account holder is required to take out in minimum required distributions (RMDs) once they reach 70.5 years old. RMDs are calculated based on the total amount in the account and the life expectancy of the account holder. The account holder must take a certain percentage each year by December 31st or be penalized. Inherited IRAs may also require RMDs regardless of age.

How FMVs are Performed

First, a qualified and independent third-party must perform the valuation. This party can be a certified appraiser, a licensed real estate professional (in the case of real estate property), or a financial expert (such as an attorney, CPA, or financial planner). However, the party cannot be a disqualified person, such as a relative or someone who gains to benefit from the valuation of your account assets.

An unsigned appraisal report is sufficient if the appraisal is required. If it’s not required, then a third-party evaluator must verify the form with a signature and date. While valuations don’t always come with a cost, the funds must come from the retirement account if payment is needed. Personal checks and cash aren’t allowed as viable means of payment. If the account doesn’t have enough free cash to cover the cost, the plan owner must make a contribution, transfer, or rollover to pay for the service.

Tips to Know About FMVs

  • You must obtain separate valuations for each asset in your account. For instance, if you have real estate and private placement investments through your IRA, you must perform two separate valuations.
  • The worth of the assets is determined based on the fair market value at the time of the assessment, not how much you paid for the asset. The FMV could be more or less than the original cost of the asset.
  • As of December 31st of the reporting year is when values are assigned.
  • The FMV form must be signed and dated by the account holder.
  • FMVs are also required when taking an asset distribution, converting an asset, or recharacterizing an asset.
  • Precious metals, brokerage accounts, and publicly traded assets and cash do not require an FMV because the market automatically determines the cost. Statements that include the unit/share balances can be used for the valuation of these types of investments.

To complete a Fair Market Valuation form online, click here. You may need to produce supporting documents, including a Comparative Market Analysis for real estate properties.

Penalties for Early IRA Distributions

You may have found yourself in a tough financial spot, or you may just really want to go on a nice vacation this year, and your only extra funds are tied up in your IRA. It’s tempting to borrow from your retirement, but there are several costs to consider before you book any flights to Italy. You can take distributions from an IRA without penalty once you’ve reached 59 ½ years of age, or have had a Roth account for at least 5 years regardless of age (on contributions only, not earnings). Of course, there are a few exceptions to this rule which are explained further below. However, if you do not qualify for one of these exceptions, the penalties for early distribution can be severe.

  1. Early distribution penalty. If you haven’t reached that 59 ½ mark, an early distribution can cost you 10% in fees on the amount you withdraw. If it’s from a traditional IRA, you will also have to pay taxes on top of that 10% penalty. Even with a Roth IRA that you’ve had for at least 5 years, you won’t be able to withdraw on earnings until you reach 59 ½. You can, however, withdraw on contributions at any age as long as the account is at least 5 years old.

Exceptions to the early distribution penalty include using the funds to pay for college, medical expenses that exceed 10% of your AGI, medical insurance if you’ve been collecting unemployment for at least 12 weeks, a first time home, and income lost due to a work-ending physical disability. You may also take early withdrawals if you’re an active duty member of the military, if you’ve inherited an IRA and haven’t rolled it over into your own account, or if you need money long-term and utilize the Substantially Equal Periodic Payment plan.

  1. Catch-up later not an option. Because IRAs have yearly contribution limits of $5,500, you may be prevented from replacing those borrowed funds at a later date depending on the size of the sum. You can take advantage of “catch-up contributions” after age 50, but it only increases the limit by $1,000 each year. If you’ve withdrawn $20,000 or more, you won’t be able to replace that amount by the time you reach 70 ½ when RMDs are required. Not to mention, you will lose out on the compounded interest on those funds as well.
  2. Forfeit compounding interest. Even if you manage to avoid the 10% early withdrawal fee, you will still end up losing a significant amount of money in compounded interest those funds would have earned in the long run. Even a modest distribution could cost you tens of thousands of dollars in retirement.
  3. Higher tax bracket. If you aren’t careful, a large distribution from a traditional IRA can bump you up to a higher tax bracket which can cause you to owe even more than the initial 10% penalty and original tax amount on your funds. Some people don’t realize IRA distributions count as income, and an early withdrawal ends up costing them a lot more than they previously thought it would.

While there are legitimate reasons to take an early distribution on an IRA, they are few and far between. The account holder must weigh every cost before making a decision one way or the other. Most financial advisors recommend leaving IRA funds alone until you’re 59 ½ because the costs almost always outweigh the benefits. If you aren’t sure what’s right for you, your financial advisor can provide you with a more personalized look into how your account will be affected by an early distribution.