Year-End RMD Ideas

Comments on “Many Retirees Limit Withdrawals to the RMD Amount,” by AAII Staff, in the November 2020 AAII Journal:

You may have done your readers an additional service by explaining how to use the required minimum distribution (RMD) withholding as a strategy to offset required estimated tax payments due to the manner in which withholding from an RMD is considered to be distributed across the entire year. This strategy uses the RMD withdrawal to pay taxes, which will still be required, and provides control over the timing of these payments.
—Claude Inch

If you think the market will grow, use RMDs in December to pay most of your income tax. Luckily, by having a defined-benefit plan we get far more than we need to live on. The excess plus our Social Security has gone into stocks for years. With normal withholding on the retirement plan, we avoid quarterly tax on capital gains and dividends. In late November, we compute our year’s tax. In December we order the RMD with sufficient tax withheld to cover the whole year’s federal and state tax.
—Sandy Mackenzie from Kansas

People taking RMDs and who are on Social Security must realize that their marginal rate will likely be much higher than the tax bracket they happen to be in if they take additional amounts from their IRA. The marginal rate could be significantly higher. You can only add income up to the top of your tax bracket without paying excessive taxes if you are not currently on Social Security and taking RMDs.
—Richard F. from Minnesota

Since there are no RMDs on your IRA this year, is there a tool for determining how much you can transfer from your IRA to your Roth IRA before you have to pay a tax?
—Robert A. from Florida

Charles Rotblut responds:
Robert, any amount converted from a traditional IRA to a Roth IRA is taxable in the year it occurs. If you can estimate what your taxes will be for 2020, you can determine how close you may be to hitting the next tax bracket and/or triggering higher Medicare premiums. The tax forecasting worksheet in our tax guide provides a framework for doing this type of estimation.

Personalized S&P Portfolio

Comments on “The Benefits of Building Your Own S&P 500 Portfolio Sector by Sector,” by Craig L. Israelsen, Ph.D., in the November 2020 AAII Journal:

I wonder if a similar approach could be used to simply rebalance an equal-weighted portfolio of 11 sector funds periodically (say, annually). If it works for withdrawals, it should work equally well for a portfolio where the ‘withdrawal’ is simply reinvested in the sectors with a lower annual return.
—Nelson L. from Georgia

Nelson, I am not an expert, but I tried using the 11 Vanguard sector exchange-traded funds (ETFs) for a three-year period while in accumulation mode. I thought rebalancing within the sectors would provide a slight performance edge over the S&P 500 index (buy low/sell high). The problem I had is that the best-performing sectors continued to perform better than the worst-performing sectors. I realize that three years is too short to determine if the strategy is effective. I might have seen benefits if I stayed with the strategy longer, but I decided that a simpler portfolio was a better option for me.
—Leonard C. from Connecticut

This has led to about a 5% improvement over the Vanguard 500 Index ETF (VOO) over a 16-year period. It seems like a fair amount of work for a relatively small gain to me.
—John S. from Massachusetts

As a reminder, not rebalancing sectors is reasonable according to Sam Stovall in his AAII Journal article “A Question of (Re)balance.”

John, with a Roth IRA, avoiding gains taxes, it might be worth considering the Vanguard 500 Index fund for simplicity in accumulation and convert to sectors when in no-longer-distracted-by-time-at-work withdrawal mode.
—Hugh P. from Washington

Focus on Diversification

Comment on “Understanding Mutual Fund Fees and Expenses,” by John Bajkowski, in the November 2020 AAII Journal:

Expenses are important, yes, but they should not be paramount. They should be simply lumped in with numerous other considerations. Over my years of experience, I have learned that only two things really mattered: diversification (but no bonds), and which funds were likely to give me the best total return for the short and intermediate term. Unless your holding horizons are short term, volatility can be ignored. I thought AAII founder James Cloonan dispelled the risk myth quite effectively in his book “Investing at Level3.”
—Bud S. from Washington