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Limiting Required Minimum Distribution Costs

by Charles Rotblut, CFA

The IRS requires that funds be withdrawn from nearly all retirement accounts, including traditional IRAs, 401(k) plans, and SEPs. These withdrawals are known as required minimum distributions, or simply RMDs. Once a retiree turns age 70½, the withdrawals must be made annually. (Roth IRAs are notably exempt from this rule, and a retiree has until April 1 of the year after he turns 70½ to make the first withdrawal.)

The IRS does not specify how you should free up the cash to take the withdrawal, only that you actually take the money out. This lack of specificity provides you with some flexibility to limit transaction costs. This inaugural Retired Investor column discusses portfolio strategies for handling required minimum distributions.

Determine Your RMD

The first step is to determine how much you are required to withdraw on an annual basis. This is essentially an annual liability for your retirement portfolio, and it will be the cash goal you need to reach each year. (Any cash balances above this amount can be reinvested back into the portfolio for future growth.)

Your required minimum distribution is determined by dividing the dollar value of your IRA or retirement plan assets as of December 31 for the prior calendar year by a life expectancy factor. Appendix C of IRS Publication 590 (www.irs.gov/pub/irs-pdf/p590.pdf) has three tables with these factors. The precise table to use depends on the beneficiary of the account.

Use Income First

Once you have identified your required minimum distribution, calculate how much income your retirement account will likely generate throughout the calendar year. Factor in dividends from all of your equity holdings, including both common and preferred stock. Then determine the total sum of coupon payments from your bond holdings. Finally, factor in any fund distributions. You may not know the precise total, but you should be able to calculate a reasonable estimate.

The reason for using portfolio income first for your required distribution is that once you have purchased the retirement plan, the cash income from it is free of transaction costs. If you have previously reinvested your mutual fund distributions and enrolled in dividend reinvestment programs, consider whether you would be better served if you directly received the cash instead.

Take Advantage of Transactions

If you sell investments from your retirement account during the course of the year, consider keeping some of the cash proceeds available for the RMD. The same applies for individual bonds that mature during the calendar year. The ideas here are that you have already incurred the transaction costs for selling the equity investments and you have yet to incur any expenses for reinvesting the bond proceeds.

Since any transaction has the potential to change your portfolio’s allocation, you will need to factor in your risk tolerance and long-term goals. The sale of a stock or the maturation of a bond can free up cash, but you may need to reinvest some proceeds back into the same asset class. Similarly, a periodic review of your portfolio allocations, which you should do at least once a year, may result in the need to rebalance your portfolio. If you do need to rebalance, consider using some of the proceeds from the asset class you previously overweighted to help fund your required minimum distribution.

In both instances, your goal is to make double-duty of any retirement plan transactions.

Immediate Annuities Count Too

The lifetime payments from an immediate annuity invested in an IRA satisfy the RMD requirements for the funds invested in the annuity, according to financial planner Paula Hogan. However, a retiree still needs to fulfill the RMD requirements for retirement savings invested outside of the annuity.

—Charles Rotblut, CFA, Editor, AAII Journal

Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

Ted from CA posted over 3 years ago:

The Retired Investor column is a great idea. I hope it continues to have a separate listing in the left column under the monthly categories (editor's note, features, financial planning,etc.) in the "Current Issue" page.
Better yet, a direct link in the monthly email AAII Journal update from Mr. Rotblut like the May issue update arriving today. His brief summaries with links are very useful. And I suspect many subscribers are 65 or older and find much investment advice geared to individuals planning for retirement 20-30 years in the future, not current retirees.
Keep up the good work!


Charles from FL posted over 3 years ago:

The Retired Investor Column is a great idea. Having reached age 70 and 1/2 this year I found your column and cross references particularly useful. Please continue this column on a regular basis. Thank You.


Tom from GA posted over 3 years ago:

The one thing that I had felt was lacking from AAII was advice for those of us who had already reached retirement age. This new column will certainly be beneficial to me and my wife as we continue our independent investing in this period. Thank you.


Catherine from WA posted over 3 years ago:

Many investors on the cusp of retirement, ages low to mid-60s, will benefit from the Retired Investor column. I second the idea to embed live links to this and other key articles in the Journal update email we receive.


Keat from IL posted over 3 years ago:

My wife and I are both retired and must take our RMD's. I started my first RMD last year and my wife this year. Therefore The Retired Investor column comes in very handy for us and we wish it would become a regular column. Thanks for the very useful information.
Keat


Donald from NE posted over 3 years ago:

The Retired Investor Column is a great innovation especially for those of us who have already retired and are struggling with dealing with RMD's etc. I hope that the column will continue on a regular basis (monthly)


Richard from CA posted over 3 years ago:

In some cases you can avoid transaction costs by transferring an investment or part of an investment from your IRA to an investment account.This is simple if both accounts are managed by the same company.i.e. your broker. However transfers between companies is also possible in many cases


Bernard from CA posted over 3 years ago:

I am in the very fortunate position of not needing all of my RMD for living expenses each year; but it does provide a nice opportunity boost to any discretionary spending for things I may want. But it also could allow me to boost my estate for those who will benefit from it in the future.

I have found it not too difficult to build a spreadsheet that projects income, expenses, RMD and expected future value of investments to give me a picture of how my IRA, taxable accounts, estate and income might change in response to various strategies for using the RMD.

I also praise AAII for this column. Retirees, especially over 72+, are too often overlooked in the financial press.


Thomas from TN posted over 3 years ago:

Thank you for this. I did not know there was a specific column for retired investors.


James from IL posted over 3 years ago:

I like the addition of this column. The ideas expressed in the "Take Advantage of Transactions" are good ones. Just build up some cash during the year as execute transactions, being sure to reserve enough for your RMD. I also suggest taking out the RMD portion on a regular basis -- for example, take out 25% of the RMD at the beginning of each quarter.


Mals from MI posted over 3 years ago:

If you are till employed there is no need to take RMD from your 401K/403b plans. If I am wornd tell me why.


Mals from MI posted over 3 years ago:

I meant wrong in my previous comment and the typo made me look foolish.

I meant: If you are till employed there is no need to take RMD from your 401K/403b plans. If I am wrong tell me why.


Norman from NY posted over 3 years ago:

The approach to lower costs I have planned is to set up a "Savaings account" as a brokerage account. It is possible, from what I understand, to trasfer mutual funds (and possibly other investments) to the taxable account to meet the RMD requirements. This does not reqire selling funds, so avoids those costs.

The taxes on those funds transfered of couse need to be paid.


Richard from WI posted over 3 years ago:

Does anyone know if payments from an immediate annuity held in a Roth IRA must be taken out as they are paid or may the payments be left to accumulate and be reinvested within the Roth IRA? Are the payments taxable at any point?


Maynard from TX posted over 3 years ago:

It is also worth noting that you can also take an "in kind" distribution from an IRA. It may not be the case with all brokerage institutions but in my case there was no cost for this transaction. So you do not have to sell an asset to satisfy a RMD requirement. It is also possible to maximize the value of the RMD assuming you select an "in kind" asset distribution where the price may be lower than you expect in the future.


Bob from AZ posted over 3 years ago:

My wife and I are both retired and enjoy AAII's many helpful articles. This info about RMD's is especially useful to us right now. thanks...Bob


Donald from TX posted over 3 years ago:

Info for retirees is scarce, so thank you for this column. Hopefully I am not getting too far ahead, but since our RMD is taxable income, we will take advantage of the timely reinstatement of PL 111-312, (Pension Protection Act 2006). This law allows withdrawal as an IRA Charitable Rollover for the donation of up to $100,000 to an approved organization. We will request that a check for the RMD amount be mailed directly to our Church to fulfill our current pledge. That withdrawal amount is non-taxable to us.


Arnold from PR posted over 3 years ago:

Great! we retirees were filling abandoned!


Michael from MD posted over 3 years ago:

This looks like a very useful feature for retirees. The current article on RMD is relevant to me. This topic has always been a little murky to me regarding taxes, etc. The information here will help me rethink how best manage the distribution. Thanks for this and I'll look for future articles.


Norman from AZ posted over 3 years ago:

To Mals question above about withdrawing if you are employed. I believe you do not have to withdraw RMDs from your current employers plan as long as you receive a W-2 from that employer. If you have any additional 401k/403b plans, IRAs or Keoghs, the RMDs from those plans must be withdrawn. Therefore it is important, before reaching 70 1/2, to consider rolling previous plans into the current employers plan if that plan permits it.


George from GA posted over 3 years ago:

You are allowed to take your distribution in the form of a security transfer. No need to sell unless you need the cash.Thanks.


Anthony from NY posted over 3 years ago:

At a recent NYC AAII meeting, I did an informal survey, asking members if they knew whether Roth IRAs are subject to RMDs. Attendees were roughly split: 50% said yes, 50% said no. In the first paragraph of this retirement column Charles says:

Roth IRAs are notably exempt from this rule, and a retiree has until April 1 of the year after he turns 70½ to make the first withdrawal.

Does Charles refer to a Roth withdrawal, or to the "other" IRA withdrawals? That is, to put it bluntly, are Roths subject to RMD rules???????

A little clarification is needed here, please.

Thanks.


Charles Rotblut from IL posted over 3 years ago:

Anthony,

The IRS states in Publication 590, "You are not required to take distributions from your Roth
IRA at any age."

You can see the entire publication, which covers retirement savings, at:
http://www.irs.gov/pub/irs-pdf/p590.pdf

-Charles


John from TN posted over 3 years ago:

Since the topic of Roths has been brought up, maybe a future column addressing the conversion from traditional IRA to Roth IRA is in order. I will not begin RMD's until 2013. I anticipate at that time I will not need the total amount of the RMD and would prefer to convert part into a Roth. A column addressing various things to be considered in this situation would be helpful.-John


Dan from FL posted over 3 years ago:

A retired investor column has my vote!

I am a few years out from the RMD but there are many long and short term planning factors that would be good to explore. One that comes to mind is I read somewhere that a 401 is treated differently than an IRA when inherated?


Donald from CA posted over 3 years ago:

The following two sentences are not well edited in my view: "Once a retiree turns age 70½, the withdrawals must be made annually. (Roth IRAs are notably exempt from this rule, and a retiree has until April 1 of the year after he turns 70½ to make the first withdrawal.)"
Based ont he data presented, it would have been better editing to write either:
"Once a retiree turns age 70½, the withdrawals must be made annually, and a retiree has until April 1 of the year after he turns 70½ to make the first withdrawal. (Roth IRAs are notably exempt from this rule.)"

Or
"Once a retiree turns age 70½, the withdrawals must be made annually. A retiree has until April 1 of the year after he turns 70½ to make the first withdrawal. Roth IRAs are notably exempt from this rule."



Dave from WA posted over 3 years ago:

Thanks for this article, just wish it was longer.

Point of note, as I see a lot of comments about waiting until April 1 of the year "after" you turn 70.5, which is exactly correct. Just remember if you do wait you will need to take TWO RMD's in that year - since you are taking the first one as well as the one for age 71.

Also, if you invest in NTF (no transaction fee) Mutual funds, you can avoid all fees necessary in selling your funds and can re-invest the dividends as well.


Lanette from TX posted over 3 years ago:

I received the quarterly mutual fund update. With the prevalence of ETF's (and less interest in mutual funds), could this publication be expanded to include ETF's. I think this would be of significant interest and it would be keep up to date with current concepts in the investing market.


Lanette from TX posted over 3 years ago:

I received the quarterly mutual fund update. With the prevalence of ETF's (and less interest in mutual funds), could this publication be expanded to include ETF's. I think this would be of significant interest and it would be keep up to date with current concepts in the investing market.


Jack from VA posted over 3 years ago:

A comment to Donald of Texas. An IRA Charitable donation is great if it is to a charity you would not otherwise support. But to use it to satisfy a pledge to your church accomplishes nothing as you will be paying taxes on the money you would have otherwise deducted when donated to the church. No free lunch!


Hank from NY posted over 3 years ago:

Richard from California is absolutely correct, One may transfer holdings rather than cash. Further, some firms (TD Ameritrade) is an example) will use the prior nights close as the value so you may transfer the correct number of units. So if you have a RMD of $3600 and last nights price was 20.46 you may move 176 shares to satisfy the requirement.


Dan from FL posted over 3 years ago:

The Retired Investor column is a great idea. I hope it continues to have a separate listing in the left column under the monthly categories.

If you have seperate a IRA and (IRA annuity) and you calculate your distribution based on the total value, can you just take the distribution from just the IRA annuity and not touch the IRAs?

My though is you ave more control of the IRA..


Arden from NC posted over 3 years ago:

The Retired Investor segment isvery much needed & appreciated. It is very difficult to find good information for the already retired investor. Please continue the good work.


William from CA posted over 2 years ago:

To John from Virginia. A direct transfer from your IRA to a qualified Charitable organization does not increase your adjusted gross income (AGI) on your form 1040 whereas a withdrawal does. Therefore, you benfit by not losing as much on your medical deductions (7.5% of AGI) or your micellanous deductions.


Thomas from WA posted over 2 years ago:

Great idea to have a column devoted to retirees. Please keep it going.


Charlie from FL posted over 2 years ago:

This column devoted to retirees ( and near retirees ) is great ! Thanks very much. Also the member comments are very helpful.


L from MD posted over 2 years ago:

I am 82 and own a nice portfolio which is primarily in equities that have a lot of capital gains. I want most of this portfolio value to be left to heirs and charity but do not want to give it to them yet. My problem: investment advisers suggest that people my age should hold a high bond allocation in their portfolios. What is the best way to make the shift from equities with large cap gains to bonds considering taxes, cost basis step-up when I die, etc. I am looking for a logic to determine the optimum speed to sell off equities and buy bonds with the after taxes proceeds. Explanations and references to studies/articles on this problem would be much appreciated. Thanks in advance for any advice.


Charles from IL posted over 2 years ago:

L-You have two considerations. The first is your allocation. If you have an approximate idea of what you need for future expenses (err on over-estimating what this number will be) and what will be left to your heirs, you could split your portfolio into two parts--with one portion set aside for your heirs that has a potentially higher allocation to stocks than the other portion. The second consideration is adjusting your allocation, particularly for the money you will need to live on. If you have a large amount of unrealized capital gains, I would consult a tax professional to see if there is a way you can make the allocation adjustments while limiting the tax penalty. Depending on the size of your portfolio, it may also be helpful to consult an estate attorney. -Charles Rotblut, AAII


Ronald from PA posted over 2 years ago:

A charitable contribution, even to charities that you normally support, made directly from your IRA as part of your RMD is to your advantage if you do not itemize deductions on your federal tax return. It should be noted, however, that unless extended, this provision in the tax law will not apply for tax year 2012.


Jerry from UT posted over 2 years ago:

My planner indicated that I can transfer stock or mutual funds from my IRA to my taxable account to satisfy my RMD requirements and avoid transaction fees. I have not found any discussion of this point in the article or discussion threads. Does anyone have a comment on this approach? Thanks.


Elaine Stuart from KS posted about 1 year ago:

This column for people already in retirement is much appreciated and I hope it continues.
Thanks, Elaine from Kansas


John Samsell from WA posted about 1 year ago:

This is one of the best sites I have visited on AAII. Of course, I am retired and worried about the RMW in another year. I have responsible children and am worried about their financial future because of Govt. financial irresponsibility. There lives are not going to be as free as ours were. The quality of their childrens' lives are also being compromised. How can I maximize what I leave to them and their children?? Ted Samsell Washington State


Tom Dicks from WA posted about 1 year ago:

i am aptoaching time for rmds is there a way i can transfer ira stocks fromira account to taxable account so i don't have sell aprciated long term investments?


Dave Laliberte from MA posted 6 months ago:

With the new Obama surcharges on medicare premiums and on "unearned" income, it is becoming more complex for us married retirees to plan to stay below the $250,000 yearly income mark when figuring in the RMD's as well as other taxable gains and income. As I doubt that the income mark will change from year to year, it will only suck in more retirees each year as the previous AMT tax has done in the past! Trying to avoid the AMT tax,and the Obama surcharges, and the RMD calculations has made for a very busy retirement!
I thought that retirement was a time for a more simple life. Boy, was I ever wrong! And all of the above does not even include estate planning and portfolio monitoring and bond and stock picking!
Please, no one please suggest a "government tax simplification study commission" since in the past they have actually made things MORE complicated!


Ernesto Mendoza from MD posted 3 months ago:

As a retiree, being a lifetime member of the
AA11 is paying of w/ articles for seniors.
Thanks and my humble gratitude.


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