Distributions from a Deferred Retirement Account

By Frank Minuti, CPA

Distributions from deferred retirement accounts are taxable to the recipients in the year withdrawn. In addition to being subject to income taxes, distributions taken before the taxpayer reaches age 59½are also subject to early withdrawal penalties of 10½ federal and 2.5½ California. In limited situations a distribution taken before age 59½ can avoid the early withdrawal penalties but not income tax. The rules are strict and you need to confirm your situation with a qualified tax advisor prior to withdrawing a distribution before age 59½.

Due to the economic crisis in 2008/9 Congress permitted taxpayers to elect not to take the Required Minimum Distribution (RMD) in 2009. Taxpayers age 70½ or older must start/resume taking the RMD distributions in 2010. The distributions are taxable income to the taxpayer. The penalty for failure take the RMD is 50½ of the RMD dollars not taken. This means that if a taxpayer’s RMD for 2010 is $15,000 and the taxpayer fails to take that distribution in 2010, the taxpayer will be assessed a penalty of 50½ of the RMD ($7,500 in this example). The penalty is reported on the taxpayer’s 2010 personal income tax return.

We received a question related to the RMD from a taxpayer over age 75 who has been receiving RMD’s for a few years. He has a self directed IRA which is 100% invested in real estate trust deeds. The borrowers have not been making payments and his IRA does not have the cash to make the RMD payment to him. His IRA custodian says the distribution is required and the RMD calculation amount is based on the total value of the all notes (performing or not) in his IRA account.

He indicated that that on two different occasions in phone calls to the IRS, the IRS "informally" agreed that since the IRA did not have funds to make an RMD payment, one was not required. I could not find anything to support this position. Unfortunately, in this situation if the RMD distribution is not made the 50% penalty will be assessed. To satisfy the RMD payment and to avoid the 50% penalty the IRA administrator could distribute a percentage of one or more of the notes held in the IRA. Illiquidity does not eliminate the 50% penalty.

If you inherit a tax deferred IRA from a decedent who has already starting receiving RMD’s you must continue to withdraw RMD’s annually based on the decedent’s life expectancy. If the decedent has not started taking RMDs and had not reached age 70 ½ then you can take annual RMD distributions over your life expectancy. In either case, you must start taking an RMD distribution annually.