Required Minimum Distributions
IRA to Charity Distributions
With the arrival of the holidays, we are thinking about family get-togethers, holiday gifting and parties. But right behind the good times is tax season. Before you get busy with holiday festivities, take the time to consider a couple of things you can do now to avoid or reduce potential penalties on your 2017 tax return.
Underpayment Penalty – If you are a wage earner, you may not have had enough income tax withheld from your paycheck to meet your tax liability for the year. Or, if you have wages and also have taxable income from other sources such as investments, a second job or a side business, or if you are married and your spouse is also employed, your withholding for the year may not be enough to cover your 2017 tax liability.
If your advance payments toward your 2017 tax liability, through withholding and estimated tax payments, are less than 90% of your 2017 tax or 100% (110% for high-income taxpayers) of your 2016 tax, you will be hit with an underpayment penalty. There is no penalty if the tax you owe is less than $1,000. When the underpayment penalty does apply, it is figured on a quarterly basis, so making an estimated tax payment late in the year will not reduce the penalties from earlier periods. However, wage withholding is deemed to be paid evenly throughout the year, allowing you to mitigate underpayments earlier in the year by increasing your withholding late in the year. If your state has a state income tax, be sure to consider whether you also need to adjust your state income tax withholding to offset under-withholding earlier in the year to avoid or reduce a state underpayment penalty.
Under-Distribution Penalty – The government doesn’t want you to leave your money untaxed in your traditional IRA or qualified plan indefinitely. Thus, the tax law says you must begin taking required minimum distributions (RMDs) once you reach 70½ years of age*. So, if you turned age 70½ in 2017 or reached 70½ in an earlier year, you need to take your RMD for 2017 or face a draconian penalty equal to 50% of the amount you should have withdrawn for 2017.
The minimum distribution for any year is based upon an annuity factor for your age divided into the balance of your account on December 31 of the prior year.
With one exception (see next paragraph), when you are required to make an RMD, you must withdraw the funds for the year from your traditional IRA or a qualified plan by December 31. You may withdraw more than the minimum required amount, but if you do so, you can’t use the excess as a credit toward the next year’s required distribution.
Delayed First-Year Distribution – A special rule allows you to delay your first RMD, for the year you turn 70½, until the first quarter of the next year. This means if you became 70½ in 2017, you could delay your 2017 withdrawal until no later than April 1, 2018. But if you do that, you are still required to take your RMD for 2018, so you will be doubled up in 2018 with the delayed 2017 distribution and the regular 2018 distribution. Delaying the 2017 distribution may or may not be beneficial taxwise, depending on your tax bracket for each year. If 2017 was your retirement year, your income tax bracket may be higher than it will be for 2018, so it may be advantageous taxwise to delay the 2017 distribution until 2018.
Special IRA-to-Charity Provision – There is a special provision that applies to taxpayers age 70½ and older to directly transfer up to $100,000 a year from their IRA to a qualified charity. So, if you are 70½ or older and make an IRA-to-charity transfer, you won’t get a charity deduction; instead—and even better—you will not have to pay taxes on the distribution, and because your adjusted gross income (AGI) will be lower, you can benefit from other tax provisions that are pegged to AGI, such as the amount of Social Security income that’s taxable and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward your annual RMD.
*Exception: Distributions from qualified plans such as 401(k)s, but not IRAs, do not have to begin until the year of retirement.