Morningstar Advisor - Spring 2008 - (Page 36) Spotlight Do’s and Don’ts of RMDs By Natalie B. Choate When clients begin taking required minimum distributions, follow these strategies to maximize the value of their IRAs. Here are 10 strategies you can use to help clients maximize the value of their IRAs once they begin taking required minimum distributions (RMDs)—and sometimes even before. Don’t pay the IRA’s brokerage commissions using outside assets. Only the IRA’s manage- ment and advisory fees (including “wrap” account fees), not transaction costs, can be paid with outside assets, says the IRS. Do pay the IRA’s investment management fee out of the IRA itself if the IRA is overfunded. 1 or other hard-to-value assets, there is a problem in computing the RMD. If you take the total account value and divide it by the applicable factor to arrive at the RMD amount, then take the RMD in cash (using the IRA’s least-hard-to-value asset), you risk a 50% penalty if the IRS later determines that you undervalued the hard-to-value asset. Do distribute the required percentage of the hard-to-value asset (plus the same percentage of the other assets) to make up the total RMD to minimize the risk of undervaluing hard-to-value assets. If the distribution is done early in the year (shortly after the prior year-end valuation date), you are reasonably sure you have distributed the right value. If the IRS later revises the value of the asset upward, the portion of it that was distributed would also be revalued upward, thus eliminating or minimizing the 50% penalty. There could still be a penalty for underpayment of income taxes, but it would be much smaller. Find the Best Way to Pay Investment Management Fees This reduces the IRA’s value; plus, it’s a way to pay the investment expense with pretax dollars, avoiding the 2% rule. Don’t pay investment advisory fees out of the IRA that are attributable to outside assets in an attempt to sidestep the 2% rule. Investment costs related to non-IRA A client who pays his investment advisor a fee based on a percentage of the assets under management should consider the source of funds used to pay the fee. Is this client trying to shift money into his IRA (because he needs to build more funds to finance retirement) or out of his IRA (because it is already larger than it needs to be)? Do pay the investment management fee attributable to the IRA’s assets with outside dollars if the IRA is underfunded. Paying assets are not a proper expenditure for the IRA. Paying such costs from the IRA could be treated as a taxable distribution or (worse) a prohibited transaction. 2 Be Careful with Hard-toValue Assets RMDs are determined by dividing the account value by a factor (“divisor”) from the applicable IRS table to arrive at a percentage amount of the account that must be distributed. If an IRA holds real estate, limited partnership units, that expense with outside dollars is like a legal “extra contribution” to the account. The fee is a “miscellaneous itemized deduction,” tax deductible only to the extent the total of such expenses for the year exceeds 2% of the client’s adjusted gross income (the “2% rule”). Postpone the First Year’s RMD? Don’t assume that all clients are better off taking their age-70½-year RMD in the age-70½ 3 36 Morningstar Advisor Spring 2008
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