Limiting Required Minimum Distribution Costs
by AAII Staff | June 28, 2019
The IRS requires that funds be withdrawn from nearly all retirement accounts, including traditional IRAs, 401(k) plans and SEPs.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 take the money out. This lack of specificity provides you with some flexibility to limit transaction costs. This post 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. For more information on calculating your required minimum distribution, visit the IRS website: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds.
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 year, consider keeping some of the cash proceeds available for the RMD. The same applies to 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.
This article was adapted from Charles Rotblut’s piece that appeared in the May 2011 issue of the AAII Journal.
Discussion
John Darby from Ohio posted over 7 years ago:
One important point that is often overlooked is that while you must take the distribution to comply with the rules you do not have to spend it. You can place the funds into a different account. Perhaps AAII can comment , point users to past articles, or publish new ones on strategies to allow this money to grow!
Tom C from MD posted over 7 years ago:
I agree 100% with John. Reinvest the unspent excess. Also, at 67 right now, I am taking the max out of my IRA that will keep me in the 12% tax bracket so that when the RMD does kick in my IRA dollar value is less. Any dollars that I don't spend get reinvested now too. This too might be covered in the same articles John asked about.
John F from Illinois posted over 7 years ago:
You can transfer securities in kind to your brokerage account to cover your RMD. Your cost basis is the value on the day of the transfer. You can also do a Qualified Charitable Distribution (QCD) to a qualified charity and pay no tax.
John Garrisi from Florida posted over 7 years ago:
If you regularily donate to a charity (say, you tithe to your church) you can have your IRA custodian send your RMD directly to the charity. This counts as your RMD. Further, the amount does not count towards your AGI on your income tax. This means your income is less and the amount you pay for medicare is less. After you have done this, you can then take the money you were going to give to the charity and invest it. The end result is that the charity still gets the same amount that it would have, you pay less for medicare and you have more money to invest.
D. N. from TX posted over 7 years ago:
Tom C from Md is right on, but can be expanded. The current tax brackets are lower for virtually everyone and despite being "permanent," are subject to revision by every Congress and/or reversal by a change in the majority party. A couple filing jointly are in the 24% bracket up to $321,450 for 2019. If you are concerned that tax brackets will never be lower than now, it may make sense to withdraw funds in excess of the RMD or convert to a Roth.
Norma P. from CT posted over 7 years ago:
If more than one IRA is involved, the total RMD may be taken from one specific IRA account - again limiting transaction costs. An article focusing on effectively managing IRA assets based upon long-term goals and strategies would be helpful- (ie QLACs, charitable giving, beneficiaries, long-term goal for your IRAs, managing RMDS', etc.)
Steve P from MA posted over 6 years ago:
What about the Secure Act and inherited traditional IRA? My kids will need to drain the account in 10 years at a much higher tax rate. Stretch option appears to be off the table.
Charles Rotblut from IL posted over 6 years ago:
Steve, The Secure Act continues to be held up in the Senate. You could withdraw more while you are alive, but doing so could potentially increase your ordinary income rate, how much of your Social Security is taxed and your Medicare premiums. -Charles
roger webster from missouri posted over 6 years ago:
Where does it talk about how to calculate the RMD from a traditional IRA, when there are after tax dollars contributed over the years?
BRUNO B from IL posted over 5 years ago:
Roger, ifI'm not mistaken, after tax contributions should have been deducted from taxable income when filing yearly returns.
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