Should Your Required Minimum Distribution Be in Cash?

If you have a traditional IRA, the Internal Revenue Service (IRS) isn't going to let you leave it untouched forever. Once you reach age 73 if you were born between 1951 and 1959 or 75 if you were born in 1960 or after, you fall under the required minimum distribution (RMD) rules. Before the passing of the SECURE 2.0 Act in December 2022, the age was 72.

These require you to take a certain amount from your traditional IRA, profit-sharing plans, 401(k)s, 403(b)s, 457(b)s, SEPs, and a few other less-common retirement plans. It does not apply to Roth IRAs while the owner is still living.

The amount of the distribution depends on a number of factors, but for now, let's focus on how you should take it. What is the most tax-efficient way? We asked some financial advisors to weigh in.

Key Takeaways

  • It's usually easiest to take your required minimum distribution (RMD) in cash since there is no tax advantage. You can take just the dollar amount you need to, which you can't necessarily do otherwise.
  • For clients that don't need their RMD to live off and wish to lower their taxes, a qualified charitable distribution (QCD) is an option. 
  • Taking two RMDs in the same year can generate higher taxes and impact Social Security income. 

Cash or Stock?

Should you take your RMD by getting the cash or transferring the stock to another account? According to Michael J. Garry, managing member and chief compliance officer at Yardley Wealth Management, it doesn't matter for tax purposes. "There is usually little, if any, tax efficiency added by taking in-kind distributions instead of cash. Whatever comes out is taxed when distributed, and there are no embedded gains on either the cash or in-kind distribution."

He continues, "Because there is no advantage, it's usually easiest to just take cash. The advantage is that you can take exactly the amount you need to, which isn't always possible if you take an in-kind distribution of stock or a mutual fund."

He offers two exceptions, though: "First, if you don't have any cash in your IRA and either it is a depressed stock market, or a favored long-term holding of yours is depressed, it might be better to take an in-kind distribution rather than sell something at a depressed price. It won't help with taxes, but it might be the better investment decision."

"The other exception," he says, "is if you hold highly appreciated company stock in a company retirement plan and you want to use the net unrealized appreciation (NUA) rules. Then you'd take the stock out, pay taxes on the cost basis at ordinary income tax rates, and pay long-term capital gains rates on the rest of the appreciation (whether you sell immediately or in the future)."

Give It to Charity

If you have to take it, you might want to donate it. Wayne Bland, a financial advisor and retirement plan consultant with the Charlotte, N.C.-based Metro Retirement Plan Advisors, says, "For clients who don’t need their RMD to live off and wish to lower their taxes, I would consider a qualified charitable distribution (QCD). QCDs automatically satisfy required minimum distributions in the year the QCD is made. The IRS permits annual direct transfers to a qualified charity up to $100,000 of tax-deferred IRA savings."

Wait Until April 1?

Michael Tove, Ph.D., president and founder of AIN Services in Cary, N.C., says, "The law permits someone who is starting RMDs the first time (having reached age 73 or 75) to defer taking their first RMD until April 1 of the following year." But he goes on to say that it's probably not the best idea to wait because the person will have to take two RMDs in the same year, which could possibly generate higher taxes and have an impact on Social Security income. 

He also provides another example: "Let's assume a taxpayer who is 73 or 75 on (or before) December 31 of the current year has an IRA worth $100,000. The RMD will be $3,650. For purposes of this illustration, assume the IRA account neither grows nor falls other than the removal of the RMD itself. If the $3,650 RMD is taken by or before December 31, the account value at the close of December 31 is $96,350. The RMD for the next year will be $3,636. However, if the first RMD of $3,650 is taken anytime from January 2 through April 1, the RMD due for that second year is based on $100,000 and would be $3,774."

He continues, "Taking the first RMD after December 31, though permitted by law, results in the second RMD being unnecessarily increased by $138. That may not be a lot in the grand scheme of things, but money is money. And the total amount of distribution reported in the second year just jumped from $3,774 to $7,286. Finally, considering the average IRA in this country is closer to $300,000, each of those bites just tripled in size."

What Is Required Minimum Distribution and How Is It Calculated?

Required minimum distribution is the monetary amount that you must withdraw from your retirement accounts at a certain age. It is obligatory to do so by law otherwise there will be penalties. The amount is calculated by dividing the account's prior year-end fair market value by a life expectancy factor. The factor is published by the IRS.

At What Age Do Required Minimum Distributions Begin?

If you were born between 1951 and 1959, RMDs begin at 73. If you were born in 1960 or after, they begin at 75.

How Do You Avoid Paying Taxes on RMDs?

As many retirement plans are funded with pre-tax dollars, such as 401(k)s and traditional IRAs, they are taxed when the funds are withdrawn. So when you begin taking RMDs from these accounts, they will be taxed.

The Bottom Line

All of the advisors we asked agreed that aside from using the QCD, there's little you can do to avoid paying taxes. Tove says, "There's no such thing as a most efficient tax way to take RMDs. The distribution is reported annually on Form 1040 as taxable income. Whether it is taken monthly, quarterly, or annually makes no difference."

Article Sources
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  1. U.S. Congress. "One Hundredth Seventeenth Congress of the United States of America," Page 831.

  2. Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)."

  3. Internal Revenue Service. "IRA FAQs - Distributions (Withdrawals)."

  4. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs."

  5. Internal Revenue Service. "IRS Reminds Retirees of April 1 Deadline to Take Required Retirement Plan Distributions."

  6. Internal Revenue Service. "About Form 1040, U.S. Individual Income Tax Return."

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