How Do I Take an RMD from an Illiquid Asset?

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There exist “alternate investments” that are not publicly priced and traded or have financial hooks, which makes them harder to trade. That is why they are called illiquid. Examples might include limited partnerships, collectibles, art, antiques, real estate, and many of the holdings of hedge funds. We do not recommend such investments. In order to safeguard your money, we suggest that you insist on publicly priced and traded investments and avoid financial hooks. However, if you already have one of these investments in your Traditional IRA, that advice does not help.

The IRS requires that Required Minimum Distributions (RMDs) be taken from all Traditional retirement accounts, regardless of whether the asset is liquid or not, after age 70 1/2. There a several ways you can take an RMD for an asset that is illiquid.

The simplest option is to take the RMD from a Traditional IRA which has liquid assets. The caveat here is that you can only aggregate RMDs for the same account type (with a few exceptions). In other words, all IRA RMDs can be taken from one IRA and all 403(b) RMDs can be taken from one 403(b), but you can’t take and IRA RMD from a 403(b).

So what if you only have a single IRA, and it’s invested in only an illiquid asset?

If you have not yet reached age 70 1/2, you could convert the IRA to Roth and avoid the RMD entirely. Roth IRAs do not have RMDs, and the assets will get to grow tax free for the rest of your life.

If you are over age 70 1/2 but are still working, you could contribute $6,500 to your IRA using a nondeductible contribution, take your RMD from that contribution, and then convert the illiquid asset and anything remaining in the Traditional IRA to Roth. This only works if your RMD is less than $6,500 though.

If all of that doesn’t work, the most common solution is to distribute a percentage of your assets from the Traditional IRA in-kind, meaning without liquidating.

If you hold illiquid securities in your Traditional IRA, you can transfer out a percentage of the asset you own and distribute them into a taxable brokerage account to satisfy the RMD. This step may require involving lawyers to aid you in retitling the asset.

The shares would need to be valued on the day of distribution, and you would be taxed on the fair market value of those shares on that day. This would also become your cost basis should you ever be able to sell the asset in the future.

The tax penalty for failing to take an RMD is steep at 50% of the amount you fail to take, so it is essential that you make the effort to take your RMD, even when having illiquid investments creates extra hassle.

Photo by Mira Bozhko on Unsplash

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Wealth Manager, CFP®

Courtney Fraser is a Wealth Manager at Marotta Wealth Manager, specializing in retirement accounts, required minimum distributions, and Roth conversions.