IRA.Retirement

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Tip to Save Taxes on a RMD – Transfer “In Kind” Stock

StocksWe are all faced with the dilemma of taking Required Minimum Distribution from our IRA accounts when we turn 70 years old. If you have accumulated large IRA’s (including transferred 401K accounts), this can be a problem:

  • You may not need the approx. 4% annual amount
  • The RMD when added to your pension and Social Security might put you in a much higher tax bracket, Social Security might be taxed at a higher rate
  • You have to pay income tax on the RMD as “ordinary income”, not getting any preferred tax rate break

There are a few ways to help minimize taxes with your RMD. For example, you can use an actual “in kind” stock transfer. This works really well when you have good quality stocks held in your IRA that are currently depressed. Instead of taking the RMD in cash (or selling stocks for cash), just transfer the actual stock “in kind” to your taxable account. You will still pay tax as ordinary income on the RMD stock value, no way around that. However, the appreciation of that stock in your taxable account will be under the Capital Gains tax rate, today 15%.

Here is an example:

A 71-year-old man in the 30% tax bracket takes an in-kind RMD of a stock position worth $50,000 at the time of the distribution. He’d owe $15,000 in taxes on the distribution. His cost basis on that stock in the taxable account would be $50,000. If the stock goes up to say $80,000 in the next three years and he decides to sell, his tax bill would be $4,500–his $30,000 gain multiplied by the 15% capital gains rate.

However, let’s say that same person keeps the depressed stock in the IRA and takes a distribution of $50,000 in cash from the IRA instead. His tax bill on the RMD would be the same–$15,000. But if he were to then sell the same stock 3 years later from the IRA at a market value of $80,000, his tax bill on that distribution would be $24,000.

The tax savings would be substantial, a $19,500 tax savings.

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5 Advantages of Roth IRA’s you may not have considered

 

Roth

In the years leading to retirement you face a decision, whether to fund a Traditional IRA or a Roth IRA.

  1. Tax-free withdrawal. This you already know, however another major advantage of a Roth is that withdrawals are not included in any “income” calculations, including Social Security benefits or the current 3.8% surtax on net investment income above $250k for joint returns.
  2. No minimum distribution. Have a sizeable IRA in retirement is both great and a problem. The problem is that at age 70 ½ you must begin a Minimum Distribution from an IRA, and if you do the math, it isn’t so “minimum”. If you really don’t need this money, you first pay taxes on it as ordinary income, then you invest it into a taxable account and continue to pay taxes on it. The Minimum Distribution possibly raises your tax rate on your Social Security benefits. The Roth is 100% tax free after the age of 59 ½ with no requirements to ever distribute it.
  3. Penalty free withdrawal. If you fund a Roth IRA you can withdrawal your contribution with no tax penalty. A withdrawal from an IRA before 59 ½ incurs both income tax and a 10% penalty. A Roth can become an emergency fund if necessary.
  4. Estate planning. With a Roth you can pass your account to your heirs and other than an annual tax free withdrawal the account could continue for decades all tax free. The power of compounding could turn a modest account into a 7 digit account in no time. A Traditional IRS can be left to heirs but they must pay taxes on the annual withdrawals.
  5. Conversion flexibility. Let’s say that in January you convert $100,000 of Apple stock from a IRA to a Roth, you immediately incur a tax liability for $100,000 of income. Unfortunately by October 15th the market has dropped substantially and this investment is worth only $75,000. You can actually reverse the conversion (still only $75,000) and eliminate the tax on $100,000. This protects you in a down market. Of course if the market goes up as in the last few years you are even further ahead with a conversion.