Once you reach a certain age, a traditional IRA has to pay out a minimum amount every year. That's a required minimum distribution, or RMD. If your IRA's money is tied up in a loan, you need a plan to cover it.
This one catches a lot of older lenders by surprise. Here's how to plan ahead.
When RMDs start
Under current law, RMDs start at age 73 for most people. If you were born in 1960 or later, they start at 75. The first one can wait until April 1 of the year after you reach that age. After that, it's due by December 31 every year.
Roth IRAs are different. The original owner of a Roth IRA never has to take RMDs. If you're lending from a Roth, this mostly doesn't apply to you.
How much you have to take
Your RMD is based on your IRA's value at the end of last year and an IRS life expectancy table. Your custodian usually figures it for you. The older you get, the bigger the share you have to take.
That value includes the loan your IRA made. Your custodian may ask for its value each year.
Free lender guide: 5 questions to ask before you lend to anyone, plus a 12-item document checklist.
The problem with lending
Cash in a savings account is easy to pay out. A loan isn't. If most of your IRA is lent out, there may not be enough cash in the account when the RMD is due.
4 ways to plan for it
- Keep cash in the IRA. Leave enough cash in the account to cover a year or two of RMDs.
- Use the loan's payments. If the loan pays monthly or quarterly into your IRA, those payments can build up the cash for your RMD.
- Take it from another IRA. If you have more than one traditional IRA, you can add up the RMDs and take the total from any of them. This doesn't work with 401(k)s.
- Take it in kind. Some custodians can move part of an investment out of the IRA to you instead of cash. It's more complex, so ask your custodian and CPA.
Don't miss it
If you miss an RMD, the penalty is 25% of the amount you should have taken. It drops to 10% if you fix it quickly. Put the date on your calendar, and talk with your custodian every fall.
See how to lend from your IRA, step by step, and how Roth and traditional IRAs differ.
Common questions
Do Roth IRAs have required minimum distributions?
Not for the original owner. Beneficiaries who inherit a Roth IRA usually do have to take money out.
Can I take my RMD from a different IRA?
Yes, for traditional IRAs. You can add up the RMDs from all of them and take the total from one or more. 401(k) RMDs have to come from each 401(k).
What's the penalty for missing an RMD?
25% of the amount you should have taken. It can drop to 10% if you correct it within the IRS's time window.
Written by Larry Hoffman
Managing Member of LJH Investments, LLC in Madison, Indiana. In real estate since 2006, with 300+ mortgage notes bought. Author of Mailbox Money Retirement.
General education, not tax, legal, or investment advice. IRA rules are strict and change over time. Confirm everything with your custodian and a CPA or tax attorney. All investing has risk, including loss of principal.