What is a Required Minimum Distribution or an RMD?
At age 72 (unless it is a Roth IRA), people are required to start pulling money out of their IRA and pay taxes on the distribution. The IRS term for this is a Required Minimum Distribution or RMD. If they fail to take this RMD, which is based on the value of the account and the age of the IRA holder, there is a 50% penalty (of the RMD amount). An RMD calculator is a good tool to bookmark to ensure compliance with all IRS regulations. Over the years, there have been occasions when a client has been in a perplexing dilemma regarding liquidity of their IRA-owned asset and their IRA RMD. While RMD’s are based on the aggregate of all your IRAs, regardless of how many custodians you have, the RMD can be taken from any (or all) of the custodians. It does not need to come out proportionally from each custodian.
RMD’s in Liquid vs Non-Liquid Assets
In many cases, our clients have non-liquid assets in their accounts. They take their RMD from remaining cash and/or another, more liquid, IRA account. These are the easy cases. But what happens if a client has a non-liquid asset and no remaining cash or liquid assets to take the RMD? While it is not a situation you want to get into, there is a solution. You can take the non-liquid asset itself (or portion thereof) as a taxable distribution.
3 Possible Solutions for RMD’s in an IRA holding a Non-Liquid Asset
For example, let’s say I am 77 years old and I have an IRA worth $100,000 as of December 31st of 2010. My 2011 RMD is $4,716.98. However, I don’t have any cash left in my account. I only have a piece of real estate valued at $100,000. I have 3 options.
- Do nothing and pay penalties of $2,359. Most woud agree this is not ideal.
- Sell the asset and take the RMD from the cash. But is market suitable for sale?
- Take a percentage of the asset out of the IRA as a taxable distribution.
In this case, I opt for option three. I have an appraisal prepared and fill out my IRA administrator’s distribution form. I also have a deed prepared issuing 5% of the $100,000 property to myself. So now, rather than the IRA owning 100% of the property, the IRA owns 95% while I own 5% personally. The IRA administrator will report to the IRS (and client) that a distribution of $5,000 occurred. This is a taxable event, even though I did not receive any cash. I received $5,000 in value instead.
As mentioned, this is not a situation you want to get involved in if avoidable. There are expenses associated each time this is done (i.e. new appraisal annually and new deed preparation annually). The client could opt to remove the asset in a shorter time frame (i.e. 25% over 4 years). However, the taxable implications would potentially be higher if the distributions occur in a shorter time frame. It is best to talk to your financial advisor or CPA before deciding how much of a distribution is best for you. A little planning ahead can usually go a long way in keeping situations like this from arising. However, it is nice to know there is an option for those stuck in this dilemma.