Required Minimum Distributions (RMD): What's Your Strategy?
By Eliseo "Jojo" Prisno, CRPC, MS
Chartered Retirement Planning Counselor
It is tax filing season again and most of our senior clients are looking into their RMD taxes. What is an RMD or Required Minimum Distribution? When you are contributing to traditional 401(k)s and/or individual retirement accounts (i.e. 403b's or IRAs), they earn you a valuable tax deduction during your working years. These deductions outright reduces your adjusted gross income which in turn reflects as tax savings. On top of this tax reduction, your retirement account gets invested normally in the stock market and over time grows through capital gains and dividend incomes. These gains and incomes compound in your retirement accounts on a tax deferred basis, meaning tax payables are suspended. But in retirement, you will need to start withdrawing the money and pay income tax on it and the maximum age you can suspend to create distribution is at 70 ½ years old. This simply means that you can opt not to create distribution or income until you reach 70 ½ even if you retire earlier; for example, if you retire at the age of 66 you have 5 years to suspend income or keep your retirement funds growing. Many of our senior clients that have attained the RMD stage have asked us what is the best strategy to minimize taxes and fees as they draw down their retirement accounts.
The best answer I found is from Emily Brandon, senior editor for retirement of US News. Ms. Brandon summed it up as follows:
"Avoid the penalty.
Withdrawals from traditional retirement accounts become required after age 70½, and each distribution is taxed at your ordinary income tax rate. If you fail to take a required minimum distribution or you withdraw the incorrect amount, the amount you should have withdrawn is taxed at 50 percent, in addition to the regular income tax you owe on it. "For the amount that doesn't come out, there is a 50 percent penalty, and on top of it is still taxes," says Frisch Financial Group in Melville, New York, a group of certified financial planners. "You could see up to 90 percent of it disappear, depending on your tax bracket." Account owners can take any number of distributions throughout the year, as long as the minimum required amount is met by Dec. 31 (or April 1 if it is your first year of required distributions). Although you are allowed to withdraw more than the required amount, you cannot apply the excess to a future required minimum distribution.
Delay 401(k) withdrawals if you are still working
If you are employed after age 70½ and don't own 5 percent or more of the company you work for, your 401(k) plan might allow you to delay 401(k) distributions until you retire. However, you will still need to take required minimum distributions from IRAs and 401(k)s from previous employers after age 70½, even if you are not yet retired.
Avoid two withdrawals in the same year. If you turned 70½ in 2014, you need to take a required minimum distribution from your retirement accounts by April 1, 2015. Your first required minimum distribution is due by April 1 of the year after you turn 70½, but subsequent distributions are due by Dec. 31 each year. If you delay your first required minimum distribution until April, you will need to take two distributions in the same year, which could result in an abnormally high tax bill. "You really don't want to take two in one year because then you might put yourself into a higher tax bracket," says PennyTree Advisers in Braintree, Massachusetts. "You want to space them out a little bit."
Calculate your distribution. Your required minimum distribution is calculated by dividing your retirement account balance by an IRS estimate of your life expectancy. Sometimes a spouse's age is also taken into account. The distribution must be calculated for each IRA you own, but the amount can be withdrawn from any IRA or combination of IRAs. A 403(b) plan also allows you to total the required minimum distributions and take them from any account or combination of accounts. However, withdrawals must be taken separately from each 401(k) account.
Roth IRAs don't require distributions
Although you need to take withdrawals annually from traditional and Roth 401(k)s and traditional IRAs, distributions from Roth IRAs are not required in retirement thus the RMD rule does not apply. If you have Roth IRAs, you can potentially leave it to your heirs. Having a mixture of traditional and Roth can be very valuable in retirement because then you can tinker around a little bit in retirement with your income."
The RMD rule is the most misunderstood retirement rule given its complexities specially that more and more seniors are still found in the work force even after 70 ½ years old. If you have no strategy you could end up with penalties and unnecessary tax liabilities. Always consult your financial professional or tax advisors when you are about to reach the age. A two year retirement distribution planning lead time is always best. •
About the writer: Eliseo Jojo Prisno is a Chartered Retirement Planning Counselor and for over a decade has managed the wealth of select families and business owners. He founded P/E Capital Investments in 2010 and is the current Managing Director and Senior Investment Advisor of the firm. Mr. Prisno also manages a Fund of Funds Portfolio with Ameritas and runs an All Equity Growth and Income Portfolio in Separate Accounts via E-Trade Financial. If you have questions or desire a complimentary analysis of your retirement readiness, call toll free to 1-888-929-2825 or visit our page on facebook or our website: www.PEcapitalinvestments.com.