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What are RMDs?

The IRS forces you to begin taking distributions from your IRAs and other retirement accounts at age 70 ½ (don’t ask me where they came up with the ½ a year). These are called Required Minimum Distributions (RMDs).    These must be taken from any and all retirement accounts.  If you are still working and are not a 5% or more owner in a business, the IRS allows you to defer RMDs on assets held in your current employer’s retirement account.  All other retirement accounts must still have an RMD.

The IRS does allow you to defer your first year distribution, requiring the withdrawal to be taken before April 1st of the following year.  Keep in mind you would then have two RMDs in that year (year 1 and year 2), so deferral may not be the best option (but could be).

How to Calculate Your RMD

For most, an RMD is calculated by the financial institution that holds your retirement assets.  Beginning with your January statement, you should find your RMD for the following year.  There are special rules that apply if your spouse is more than 10 years younger than you.

Tax Implication of RMDs

Distributions from retirement accounts are taxable as income.  In the event you have made non-deductible IRA contributions in the past, then a portion of your distribution will be a pro-rata return of capital.  So how do RMDs impact your taxes?

One of the fundamental characteristics of successful people is their ability to defer gratification for a larger future benefit.  If you’re reading this article, chances are you’ve diligently deferred into your retirement accounts over the years and now have a nice nest egg.  Your experience has taught you the benefits of deferring gratification, so you may be inclined to defer distributions from retirement accounts until you’re forced to.  This may not be the best solution.

Income Stacking

Prior to and throughout retirement, it’s critical to take inventory of your current and future income sources, as well as current and future tax deductions.  All of us will have some level of Social Security Income in retirement.  If you’re lucky, you may have a pension, payout from an annuity, deferred compensation, or other deferred income.  If you have assets outside of retirement accounts, you may have capital gains, dividend and interest income.  If you’re still working in some capacity, you may still have earned income.  As you begin stacking these income sources, you may have more income than you anticipated in retirement.  Great Job!  Now, keep in mind your RMD will add to these income sources.  Your first year’s distribution will be approximately 3.6% of all of your retirement accounts.  It’s not uncommon for these distributions to be relatively large, based on the size of your retirement assets, and push you into a higher tax bracket.  This can impact not only the tax rate you pay, but also your Medicare Premiums, exclusion of certain tax deductions, etc.

Income Planning

Planning when to begin your various income sources is critical to maximizing your situation. This process should be reviewed early in retirement.  It’s not always the best policy to defer retirement distributions or to defer starting Social Security until age 70 (although sometimes it is).   One common technique to reduce future tax liability is called Bracket Maximization.  With this strategy we identify how much additional income you could have before you reach the next highest tax bracket.  In this instance, we accelerate income into your current year to maximize your given bracket.  We can do this either with retirement distributions OR via Roth IRA Conversions.  We choose the latter strategy when you have no immediate need for the funds, relative to the former strategy when you want/need the extra income.  Of course, your current and future tax deductions will have an impact on your overall tax situation; and those should be considered when planning future incomes.

 

To lower lifetime taxes and maximize your situation, it’s important to anticipate all future income and deductions.  This is a complex process, but if done effectively, can have a meaningful impact on your family’s financial situation.


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