Jaime Raskulinecz, founder/CEO of Next Generation Trust Company, specializing in custodial & administrative services for self-directed IRAs.
Investors with self-directed retirement plans can include many types of alternative assets within their plans. These include real estate, precious metals, private equity funding, promissory notes, commodities, royalties and many more. In fact, the only investments the IRS prohibits in these plans are insurance and collectibles.
These alternative assets are typically long-term and relatively illiquid compared to the investment vehicles available through banks and brokerage houses, such as stocks, ETFs and mutual funds. Another difference is that when it comes time for account owners to take required minimum distributions (RMDs) using illiquid alternative assets, they will execute an in-kind distribution, so the process is different than liquidating stocks or pulling cash from a retirement account.
Why Everyone Must Eventually Take RMDs
All investors with retirement plans—both traditional and self-directed—must take RMDs each year by December 31 from pre-tax accounts. The SECURE Act 2.0 increased the age at which these distributions must begin from 72 to 73 years old for people born between 1951 and 1959. People born in 1960 and later must begin taking their RMDs at age 75. The first RMD has a grace period until April 1 of the following year. Note that you must take RMDs regardless of work/retirement status; it’s tied strictly to your age.
Note: The pre-tax provision means that this requirement does not apply to owners of Roth IRAs, but it does apply to beneficiaries of inherited Roth IRAs. There are also exceptions to the starting age for these distributions from defined contribution plans, so if you have a 401(k) or 403(b) plan, for instance, you may want to consult your plan administrator about that.
The RMD amount differs from individual to individual based on the account’s fair market value at the end of the prior calendar year and life expectancy. RMDs are calculated using all IRA assets in aggregate, while 401(k) plans calculate RMDs for each individual plan. The IRS provides calculation worksheets, which you can find here.
Failure to take one’s full RMD carries a hefty IRS penalty tax of 25% on the short amount, so make no mistake—these distributions are definitely required!
Taking In-Kind Distributions For RMDs
Remember that with a self-directed IRA, the retirement account owns the asset, not the individual taxpayer, and the plan custodian holds the asset in the name of the account. Also, regardless of what types of investments are in the account, the owner must take RMDs annually.
In accounts with illiquid assets as opposed to cash (real estate, for example), capital is tied up in those investments, and the taxpayer may not have adequate cash available to meet the RMD obligation. But don’t worry: The taxpayer may take an in-kind (non-cash) distribution that represents all or part of the shares of an asset to meet the RMD obligation.
The process is quite easy: The asset held by the custodian is re-registered (retitled) into the account holder’s name, essentially transferring ownership of the asset to the account holder, and it is then distributed. Before taking an in-kind distribution, the self-directed investor must provide a proper valuation of the asset by a professional appraiser, as it is a taxable event.
The plan custodian reports the transaction on IRS Form 1099-R. Regular income tax is due when the asset is distributed from a Traditional IRA. However, as noted above, there is no income tax triggered when the asset is distributed from a Roth IRA because the tax was already paid when the contribution was made.
Note: Every year, self-directed IRA owners must provide the fair market value for all alternative assets held in their accounts. Therefore, it’s important to leave ample time for third-party asset valuation (especially pertinent to real estate holdings) and the transfer before the RMD deadline. This valuation is reported on Form 5498.
What To Do When Capital Is Short
Some account owners find their self-directed IRA lacks sufficient cash to take the RMD. There are several ways in which to raise the necessary cash:
• In retirement accounts that hold real estate investments, the owner can sell or refinance the assets. This tactic can work with other alternative assets, such as precious metals and private funds, as the funds can be partially liquidated to account for an RMD.
• Any income received from an asset in the retirement account can be held to satisfy the RMD.
• Other retirement accounts with more liquid investments can also be used to satisfy RMD requirements. As long as the RMD is calculated over all IRA accounts that require it, the actual distribution can come from any of those accounts.
As with all aspects of retirement planning, I always recommend that clients discuss this matter with their trusted advisor and prepare for any changes the distributions may make to their overall financial picture.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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