IRA owners may take distributions of assets in cash or as securities in kind. Let’s review considerations for both options.
Cash Distribution Benefits
- Exact amount for RMD – Upon distribution, the value of the security on the date of distribution will be the amount that is reported to the IRS. Because security prices fluctuate throughout the day, it is often difficult to determine the exact value. This can be troublesome when trying to satisfy an exact required minimum distribution (RMD) amount.
- Tax withholding – While securities can be distributed in kind, federal or state tax withholding to pay the taxes due on that distribution must be sent to the IRS or applicable state in cash. This means that cash may need to be available in the IRA if electing to withhold federal or state taxes.
- Immediate cash needs – Oftentimes, individuals need the assets in their IRA for living expenses during their retirement years. If you are in need of cash, taking a cash distribution rather than an in-kind distribution from the IRA may be more beneficial.
Security Distribution Benefits
There are a variety of reasons why a distribution of securities may be more appropriate:
- Down market or depreciated security – Cost basis is not recognized while a security is in an IRA, so by taking a distribution in kind, the value of that security on the date of distribution will be the new cost basis. For example, if you purchased a security for $10,000 in a traditional IRA and the security is now valued at $8,000, by taking an in-kind distribution, you will pay taxes on $8,000 rather than $10,000. If the security appreciates in value in a non-IRA account following IRA distribution and is then sold after 12 months or longer, the gain will be taxed at long-term capital gains rates. Long-term capital gains rates are typically lower than ordinary income tax rates, so there may be tax savings by distributing securities you expect to go up in the future. Additionally, in-kind Roth conversions for securities that you believe will appreciate in the future may be beneficial, as future earnings in a Roth IRA will be distributed tax-free after five years and once you’ve reached age 59½.
- No desire to sell – Sometimes an individual doesn’t want to sell a security, because of recent performance or a likeness for the company. An in-kind distribution of that security will keep the investment intact.
- Surrender charges or illiquidity concerns – Certain securities have additional charges for selling the investment prematurely. These surrender charges are designed to discourage the investment to be viewed as a short-term trade. It may be advantageous to take a distribution in kind to avoid these surrender charges. In addition, certain securities cannot be sold because of a lack of willing investors to purchase the asset (no counterparty).
Security Distribution From a Qualified Plan
If a participant is eligible for a distribution from a qualified plan and owns highly appreciated company stock, that stock may qualify for the net unrealized appreciation (NUA) tax strategy. By taking a distribution of the company stock in kind and executing the NUA strategy, the individual will only pay ordinary income tax on the cost basis of the security and then, when sold, generally pay long-term capital gain taxes on the growth.
Compare this to rolling the company stock to an IRA and then taking a distribution, where the entire distribution will typically be taxable as ordinary income. Again, long-term capital gain tax rates are generally lower than ordinary income tax rates, making this strategy appealing. By contrast, if a cash distribution is taken from the qualified plan, the NUA strategy will not apply.
Did You Know? In 2019, 27% of IRA owners took IRA withdrawals, with the average annual amount being approximately $20,000.*
Contact your Stifel Financial Advisor to discuss which distribution method is right for you.
* Source: “The Role of IRAs in U.S. Households’ Saving for Retirement,” January 2021, Investment Company Institute
Stifel does not provide legal or tax advice. You should discuss your particular situation with your legal and tax advisors.