What goes in must come out.
That’s probably the shortest
summary I can give of last week’s post about required minimum distributions
(RMD’s) from retirement accounts. To
address what I consider the two main dilemmas posed by RMD’s—potentially pushing
the recipient into a higher tax bracket and/or making up to 85% of his Social
Security benefits federally taxable—I’ll offer some ideas here. These are very general in nature, and I do
not note all the exceptions to the rules nor explain all the pros and cons of each
option. I urge you to consult a tax
professional to chart your own financial strategy to and through retirement.
1. Put your retirement money into Roth accounts. Money invested through a Roth retirement
account is taxed before it goes in, but that money PLUS all the money earned in
the account from investing may be withdrawn tax-free after age 59 ½. Moreover, Roth IRA’s do not have RMD’s; the
money may stay in the account throughout the owner’s lifetime. Roth 401k accounts do have RMD’s. Regardless,
the money withdrawn from a Roth account is not taxable, so the two major
drawbacks to taking an RMD are resolved.
Most people can convert the money in a regular IRA to a Roth IRA, but
there are some limitations, and you want to be aware of the various pitfalls,
including the upfront tax obligation you incur.
Consult a professional.
2. Put a portion of your money into a Qualified Longevity Annuity Contract
(QLAC). I can’t say I’m a fan of
annuities, but this could be one way to reduce your RMD. You may put the lesser of 25% of your IRA
balance or $125,000 into an annuity that will start paying an annual income
starting later in retirement. One day
I’ll write more about annuities, but I’d consider this one of the least
attractive means of tax planning. Buyer
beware.
3. Marry a younger man or woman.
If your spouse is at least 10 years your junior, you are allowed to use
a different IRS table, with smaller percentages, to calculate your RMD. But your younger spouse is likely still
earning an income, and that will still put your Social Security benefits in the
tax man’s sights. There are better
reasons for marrying.
4. Roll all your savings into your workplace 401k and keep working. Unless you own 5% or more of the business,
you do not have to take RMD’s from your employer’s regular 401k account as long
as you continue working for that employer.
If the plan accepts rollovers from IRA’s or other 401k’s, consider
parking your nest egg there.
5. Make a charitable donation.
You may have a payment made directly from an IRA to a qualified
charity—up to $100,000 per year—and it will count toward the RMD. This is an
especially attractive option for those who do not itemize deductions because
the donation does not count as income, and the full standard deduction may
still be taken.
6. Draw
down your account balance before RMD’s are required. Starting at age 59 ½, when savers can start
withdrawing from most retirement accounts without incurring a 10% early withdrawal
penalty, begin drawing money from those tax-deferred funds a little each year and
put it into taxable vehicles like CD’s or non-retirement brokerage
accounts. It still generates taxable
income, but presumably smaller amounts of it and maybe taxable at lower rates. Eleven years later your IRA balance might be
low enough that the RMD’s will not push you into another tax bracket nor trigger
taxation of Social Security benefits. It
requires careful planning, though, since you have to include that taxable
income from your non-retirement accounts in your calculations.
One variation of this plan is to delay
taking Social Security benefits until age 70 and just live on the money in your
IRA or 401k until then. Unless you have
been a diligent saver for many years, this plan will likely deplete your
account or take your balance down to a point where the RMD may not be enough to
impact your tax bracket. Moreover, this
strategy allows your eventual Social Security benefit to grow 8% per year. Your benefit will max out if you delay
claiming until age 70, at which time it will be nearly 76% higher than if you
had begun drawing at age 62. That higher
amount alone might be enough to sustain a retirement lifestyle. The obvious downside to that is you have no
nest egg and are wholly dependent on that check from the government. How comfortable are you with that?
All of this said, for most people
the RMD dilemma may be a moot issue.
Consider Joe and Bridget, the hypothetical couple in last week’s post
and whose case study I’ve reproduced below:
2016 Tax Year calculation to determine if Social Security
benefits are taxable:
$9000.00 (50%
of Joe’s Social Security benefit of $1500/month x 12 months)
$8700.00 (50%
of Bridget Social Security benefit of $1450/month x 12 months)
$5500.00 (Bridget’s
income from a part-time teaching job)
$ 250.00 (Interest
income)
$6073.00 (Joe’s RMD based on the IRS table and
his IRA account balance of $150,000 on December 31, 2016)
$6445.00 (Bridget’s RMD based on the IRS table
and her IRA account balance of $165,000 on December 31, 2016)
_________
$35,968.00
Their situation is actually
fairly typical. Their Social Security
benefits are near the national average, maybe slightly above. The combined $315,000 in their IRA’s is a bit
above the national average 401k balance of a worker with 30 years’ tenure at
the job. Yet, even with the RMD’s they
only exceeded the income limit at which Social Security benefits become taxable
by $3968.00. If Bridget had just not
worked that part-time job, they would have come in under the limit. Their total income would still be $48,168, of
which only $12,768 would be potentially taxable. If they use their personal exemptions, the
standard deduction….hmmm…..are they even going to pay any taxes this year?
Roger
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