by Bob Rywick
An individual who is 70-1/2 in 2002 does not have to take a required minimum distribution from a traditional IRA until April 1, 2003.
Such an individual also has until at least April 1, 2003, to begin taking RMDs from a qualified retirement plan account. The same rule applies for taking distributions from a qualified plan account with this exception.
If an employee is not a 5 percent owner of the company and continues working past age 70-1/2, that employee does not have to take a RMD until April 1 of the year after he retires.
However, if an individual who is 70-1/2 in 2002 delays taking the first RMD from an IRA until 2003, he must take two RMDs in 2003. Similarly, if a non-5-percent owner of a company who is over 70-1/2 retires in 2002, but delays taking his first RMD from the company’s qualified plan until 2003, that non-5-percent owner must take two distributions from the qualified plan in 2003. This is because the first year in which a minimum distribution is required from an IRA is the year in which the IRA owner attains 70-1/2.
In the case of a qualified plan account owner who is a not a 5 percent owner of the company, it is the later of the year he is 70-1/2 or retires. While an individual may delay taking the RMD for the first distribution year until as late as April 1 of the following year (the second distribution year), he must still take a RMD for that second distribution year, as well.
Even if the first RMD is delayed until the second distribution year, the amount of the RMD is based on the value of the IRA or qualified plan account at the end of the year before the first distribution year.
Example (1): Your client, a widow, will be 71 on March 1, 2003. Accordingly, she was 70-1/2 in 2002. She is the owner of a traditional IRA that had a value of $137,000 on Dec. 31, 2001. Her RMD for 2002, the first distribution year is $5,000 ($137,000 divided by 27.4, the factor from the Uniform Table for an individual who is 70 (your client’s age at her birthday in 2002). However, your client may delay taking this distribution until as late as April 1, 2003.
Even if she delays taking the 2002 RMD until 2003, she must still take a RMD for 2003. Assume that she does not take the first distribution in 2002, and the value of her IRA is $144,125 on Dec. 31, 2002. In determining the amount of her RMD for 2003, you must first subtract the amount of the RMD for 2002 ($5,000) from the balance of $144,125 in her IRA at the end of 2002. This leaves an adjusted value for the IRA of $139,125 on Dec. 31, 2002. Her RMD for 2003 is $5,250 ($139,125 divided by 26.5, the factor from the Uniform Table for an individual who is 71).
By delaying taking her first distribution until 2003, your client must take total distributions of $10,250 in that year ($5,000 for the 2002 required distribution, and $5,250 for the 2003 required distribution).
Delaying taking the first year’s RMD until the second distribution year could have one or more of the following effects:
-All or part of the first distribution may be taxed at a higher rate to the distributee than it would have been taxed at if distributed in the first year.
Example (2): The same facts apply as in Example (1), plus your client’s taxable income before taking any of the distributions from the IRAs into account would have been $22,800 in 2002, and you expect that it will be about $23,500 in 2003. Your client is taxable as a single taxpayer and you expect that the 15 percent tax bracket will end at $28,500 in 2003.
If your client delays taking the 2002 RMD until 2003, her taxable income for 2003 will increase by $10,250 to $33,750. In effect, $5000, of this increase in taxable income will be taxed at 15 percent for an increase in tax of $750. $5,250 of this increase will be taxed at 27 percent for an increase in tax of $1,418. The total increase in her federal income taxes in 2003 would be $2,168 ($750, plus $1,418).
If your client had taken her first distribution of $5,000 in 2002, her taxable income for 2002 would have increased by $5,000 to $27,800. Because the 15 percent bracket for single taxpayers ends at $27,950 in 2002, the entire increase would be taxed at 15 percent for a total increase in tax of $750.
In 2003, her taxable income would increase by $5,250 to $28,750. Of this total increase, $5,000 would be taxed at 15 percent for an increase in tax of $750, and $250 would be taxed at 27 percent for an increase in tax of $68. The total increase in tax for 2003 would be $818 ($750, plus $68).
By taking her distributions in two years instead of one, your client’s taxes for the two years will increase by a total of $1,568 ($750 plus $818) instead of the $2,168 they would increase by if she delayed taking the 2002 distribution until 2003. Thus, taking the first distribution in 2002 would save your client $600 in Federal income taxes.
-More of the distributee’s social security benefits may be subject to tax.
-The resulting increase in the distributee’s adjusted gross income for the second distribution year may cause a reduction in deductions and/or credits that are subject to an ajusted gross income floor, e.g.: the deduction for medical expenses; total itemized deductions, which are phased out when AGI exceeds specified limits; the deduction for personal exemptions; and, the amount of nonpassive income that can be offset by passive losses from an active participation rental real estate activity.
There are some situations when it will be advisable for an individual to delay taking the first distribution from a traditional IRA or a qualified plan until the second distribution year. Here are some key examples:
-The distributee expects to be in a lower tax bracket in the second distribution year. This could result from the distributee having lower taxable income from other sources in the second tax year, or from a reduction in the tax rate that goes into effect in the second distribution year.
-The distributee expects that taking two distributions in the same year won’t cause any part of the total distribution to be taxed at a higher rate than it would be taxed at if the distributions were taken in separate years. By deferring the first distribution to the second distribution year, the distributee can continue to earn tax-deferred income on the first distribution for up to an additional three months.
-If the distributee expects to have less income from other sources in the second distribution year, deferring the first distribution to that year may enable the distributee to avoid or minimize AGI limitations in the first distribution year without causing any increase in those limitations in the second distribution year.
For example, suppose a non-5-percent owner continues to work until after age 70-1/2, and has unreimbursed business expenses in the year he retires. By delaying taking the first distribution until the second distribution year, AGI for the year of retirement will be reduced and more of the unreimbursed business expenses may be deductible as a miscellaneous itemized deduction.
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