By Randy Neumann
Because of the turmoil in the markets these days, it’s a good thing that there is some leeway in planning for Required Minimum Distributions. Let me explain. RMDs are a way for the government to collect taxes. The first Individual Retirement Account (IRA) was created by the ERISA legislation in 1974. Back then, you could put a maximum of $1,500 into your IRA.
Over time, Congress has increased the contribution limits to qualified plans to the current levels: $17,000 for a 401(k), plus a catch-up of $5,500 if you’re over age 50. Ditto for a Roth IRA and $5,000 for a Traditional IRA, plus a $1,000 catch-up if you’re over 50. However, individual Roths still have ceilings. You cannot contribute if you make over $125,000 as a single or head of household, and $183,000 based on a joint return. Additionally, you are allowed to rollover from one qualified plan to another.
In the 1980s, Congress realized that they’d shot themselves in the foot because of rollovers—they wouldn’t get any tax revenue until the account holder died. So they came up with the RMD strategy to get some money now! When the RMDs first came out in 1987, they were complex and nobody understood them. Over time, they were made less onerous and more understandable. However, do not compare simplicity with largess because the penalty for under withdrawal is still 50%!
Furthermore, it is now easy for the IRS to catch under withdrawers because the custodians of the plans must report annually to the government how much you are supposed to withdraw. They no longer have to catch you on an audit, which are few these days; they merely send you a letter of deficiency if your total does match the total provided to them by the custodians.
Now, for the good news. You get to pick and choose how much you want to take out of each IRA. This can be very important and here’s why. Let’s say that you have three IRAs. One is invested in stocks. The second is in bonds and money markets, and the third is in a variable annuity with a guarantee of 8% while in the growth phase.
How much do you have to withdraw? You must take out a percentage of the prior year’s Dec. 31 value. Although there are complicated factors to arrive at the amount, in today’s high-tech world, there are calculators available that will give you the number. Assuming that each account above was worth $100,000 (for a total of $300,000 last Dec. 31 and you are 72 years old, your RMD for this year is $11,718.75. The number is just below 4% of the account value, so if your long-term return on the account is 8%, the account will have a 4%-plus net return after the withdrawal. Not so bad.
But where do you take the money from? That’s a good question. If you have a guarantee on an annuity from a solid life insurance company, you’d want to put that on a backburner. If the stock market is down, as it is now, at year end, you wouldn’t want to take it from there either. In the above example, you have $100,000 in an account made up of money markets and bonds.
Cash is no longer king. With money market rates ranging from 0.10% all the way up to 1%, the choice is obvious. If you subtract the current inflation rate of 3.5% from a 1% money market return, the $100,000 you started with in January will be worth $97,500 in December. However, you have to pay tax on the 1%; therefore, if you are in the 25% bracket, the $100,000 nets down to $97,250. So this is the place to take your withdrawal.
The above is an example. The point of this column is that you should pay as much attention to how you harvest your portfolio as you do to how you grow and maintain it. The second point is—you can take the withdrawal in any amount from any qualified plan that you own as long as the total withdrawal amount matches the number that the IRS has from your custodians.
Good hunting.
(Fixed annuities are longterm investment vehicles designed for retirement purposes. Gains from taxdeferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 1/2 are subject to an IRS 10% penalty tax and surrender charges may apply.)
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann CFP (R) is a registered representative with securities and insurance offered through LPL Financial. Member FINRA> SIPC. He can be reached at 600 East Crescent Ave., Upper Saddle River, 201- 291-9000.
