2 Essential Strategies for Taking Your RMDs
A folder with the required minimum distributions on the page that sits above some of the diagrams. Getty Images
Depending on how much you need the minimum payouts required to live, these forced withdrawals from traditional retirement accounts like 401 (k) s and IRAs are either a substantial income or an outright nuisance. Recently, Uncle Sam has been giving retirees a respite from taking RMDs by first increasing the age at which they must be taken (from 70½ in late 2019 to 72 years last year) and then entirely on them for 2020 waived.
Now that RMDs are back, don't let a start or end-of-year lump sum be your default on how and when to take the money. Instead, the investment markets and your income needs should be your guide. Even that takes planning because you "never have to sell assets in a declining market" to take on an RMD, says Howard Hook, principal and senior wealth advisor at EKS Associates in Princeton, N.J.
You can claim an RMD at any time during the year, in installments or as a lump sum with December 31st as an annual term. First-time visitors have longer - until April 1 of the year after their 72nd birthday. An RMD is determined by dividing the balance on December 31 of the previous year by the person's life expectancy factor, which is based on age and can be found in the IRS Uniform Lifetime Table (IRS Publication 590B, Table III).
The payouts will be bigger in 2021, and that's not just because of the strong performance of the stock market in 2020 or the extra year you had for the growth of the money. It's the way the accounts are designed, with RMDs becoming a larger percentage over time. "You will move from paying out a small percentage of the account to a day that will take up the entire account and use it up," said Taylor Hammons, director of retirement at Kestra Financial in Austin, Texas. These were never meant to be legacy accounts, he says. "The only purpose of the RMD was to force retirees to take that money and pay income taxes."
LEARN MORE The Basics Of Minimum Distributions Required: 12 Things You Need To Know About RMDs
The case for installment payments
For some retirees there is nothing forced; they need the money to live. But it's hard to manage a bunch of money. A better way is to take the money on a regular basis so that it simulates a paycheck. "We set up a distribution once a month and sometimes twice a month," says Hook. "Psychologically, people cope better with it because they are used to it." An IRA administrator can help you with this.
Regularly paid distributions also provide a framework for knowing how much you have to live with so that you don't overspend. "It helps people see their monthly budget," says Hammons.
Even for retirees who do not need the income, payment in installments over the year has advantages. "It makes sure you never sell at the wrong time," says Hammons. Think of it as the dollar-cost average reversed. Dollar cost averaging is the strategy of periodically investing equal amounts in order to minimize buying in the market at the worst time - at its peak and just before a sharp decline. Selling assets on a regular basis works on a similar principle, so you never liquidate assets for the full dividend at the yearly low. The strategy works especially well when you reinvest that money in a taxable account, says Hammons. "The advantage of receiving monthly or quarterly dividends is that they are reinvesting them at an average dollar cost."
There is a downside if you don't reinvest the money and the market keeps falling. “Average dollar cost averaging, especially in a declining market, is a losing proposition,” said Bob Foland, a financial advisor with The IRA Specialists in Centennial, Colorado. “You have to sell more stocks at a lower price when the market falls. The more stocks you sell, the less engine you have to drive growth when the market turns. "
Foland prefers to hit when the iron is hot. "I'm in favor of getting it while it's good," he says. "The time to sell is when you're making money, not when your account's value has gone down." Although he supports setting up the payout as a regular deposit to mimic a paycheck, he prefers the money to come from a cash bucket rather than from selling assets throughout the year.
SEE MORE 10 Questions Retirees Often Get Wrong About Retirement Taxes
The case for a money bucket
Whether you take the RMD year round or all at once, financial planners suggest keeping a bucket of money in your retirement account to help cover the payout. Hammons suggests having at least the equivalent of this year's RMD in cash. Foland tells customers to withdraw cash for two years, and Hook recommends three. "The top-down average in a bear market is 18 months," says Hook, who adds another 18 months for the market to come back.
The cash portion can be deposited in certificates of deposit, money market accounts or short-term bond funds and replenished when you top up your retirement assets, be it quarterly, half-yearly or annually. When you rebalance a portfolio, you capture the profits of your high-flyers and reinvest the proceeds in the laggards to maintain your portfolio's predefined allocations. The cash is part of the portfolio's income allocation, Hammons says. For example, if your portfolio has a 60/40 split of equity to income and 10% is your cash bucket, the real allocation is 60% stocks, 30% bonds, and 10% cash, he says.
A cash bucket also solves a problem that many flat-rate buyers encounter when they wait for the payout until the end of the year. If you take the RMD as late as possible in a rising market, you will get an extra year of tax deferred growth, but if your investments drop sharply in December you are locked in at loss.
Retirees in this predicament who do not need the income have an alternative. "You can do the distribution in kind," says Hammons. Transferring the shares in kind from an IRA to a taxable account is another way to meet the distribution. As with any RMD, the value of the shares transferred will continue to be taxed as income.
To avoid taxes on an unwanted RMD, nothing beats a qualified charitable distribution, says Hook. Individuals 70½ years of age and older can donate up to $ 100,000 tax-free each year to charity directly in the form of a QCD.
LEARN MORE How to report an IRA charity payout on your tax return
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