Do you have a retirement income strategy? Does it take into account Required Minimum Distributions (RMDs)?
If not, you may find yourself in quite a pickle after age 72.
The IRS stipulates that a portion of tax-deferred retirement accounts must be withdrawn annually once the account holder reaches age 72 or age 70.5 if your 70th birthday occurred before July 2019. These withdrawals (RMDs) are a mechanism the IRS uses to ensure that (1) it is able to collect taxes on the money in tax-deferred retirement accounts and (2) the account holder doesn’t merely use the account as a tax-advantaged inheritance fund.
The danger of not accounting for required minimum distributions can range from dealing with the inconvenience of a higher-than-expected tax bill to running out of retirement savings. Continue reading to learn more.
Transitioning to Retirement
As you look toward transitioning to retirement, it’s important to think about how you will turn your retirement savings into retirement income. How do you expect your income needs to change over the course of your retirement? Have you earmarked certain accounts to continue growing while you use others as your initial sources of income? When do you plan to start taking social security and how might doing so affect the size of your withdrawals?
These are all vital questions to consider in order to make sure you have enough money to last through retirement. Let’s break down some of these questions into greater detail.
Stages of Retirement (And What They Mean for Your Income)
Many Americans follow similar patterns in retirement. Lots of activity often characterizes the first 10 to 20 years of retirement. Retirees have the time and energy to pursue hobbies, travel, visit family and friends, and more. Consequently, retirees will spend more of their savings during this period.
During this phase of retirement, be proactive about your RMDs by factoring them into your annual withdrawal plan. In other words, don’t draw down your accounts for the income you need and then take RMDs at the end of the year on top of this sum. That’s a great way to spend your savings too quickly and/or incur a larger-than-intended tax bill.
As Americans begin to slow down, so too does their spending. During this phase, the primary concern for some Americans will be preserving enough savings to pass on to the next generation.
If RMDs are eating into your legacy too much, it may be time to consider a Roth IRA conversion. Roth IRA accounts are not subject to RMDs. You contribute after-tax money to a Roth IRA, Roth 401(k) or 403(b) rather than get a tax deduction for the contribution as you do with regular or traditional IRAs, 401(k)’s and 403b(b)’s. This means that you may find yourself with a hefty tax bill on your hands when you convert one of your accounts into a Roth IRA. Consider working with a financial professional to calculate what you’ll owe ahead of time, develop a strategy to pay, and successfully execute this tricky (but helpful) maneuver.
This can be a valuable strategy for multigenerational tax planning. The younger you are the more advantageous it is to convert to a Roth IRA. However, the younger you are the more likely you will have higher income that will be taxed at a higher tax bracket. That is the rub. We discussed Roth IRA conversion strategies in more detail in this article.
Continued Account Growth
A sound retirement income strategy will include mechanisms to continue generating wealth. Some Americans make the mistake of assuming that they can earmark one retirement account to continue growing, not taking RMDs from it, while they draw down the others. You would have to consider the types of investments in each account to maximize this strategy. You can accomplish the same strategy by selling selected investments within a consolidated account.
Before retirement, consider investing outside a retirement account to preserve growth opportunities and shield your savings from RMDs. If you are already in retirement and RMDs are knocking on your door, don’t fret – there are other options available. One useful strategy is to reinvest your RMDs. Although you can’t put these funds back into a tax-advantaged retirement account, you can place them in a taxable investment account, where they have the potential to earn you more money (as well as, of course, the risk of losing money).
The selection of which types of investment that you allocate in your tax-advantaged and non tax-advantaged accounts is very important. You will want to allocate investments that are not as taxable (e.g. individual stocks or stock Exchange Traded Funds (ETFs) that you intend on holding) to your non tax-advantaged accounts (e.g. non IRA accounts).
Americans are eligible to begin collecting Social Security at age 62, although most Americans won’t reach full retirement age until sometime between their 66th and 67th birthdays. Those who wait to collect their benefits until age 70 are eligible to receive added benefits.
This means that some Americans might experience a jump in their retirement income from age 69 to age 73. The tax implications of this change in income can be significant. Up to 85% of Social Security benefits are taxable depending on the recipient’s income. So the potential jump in income that RMDs create can have a ripple effect, producing a greater tax bill while also lowering the amount of benefits received.
It may seem counterintuitive but it can make sense to withdraw from your IRA accounts at lower tax brackets before you are required to at age 72. The ultimate taxation can be less, even far less than waiting until the floodgates of income open at age 72 when you are receiving both Social Security and RMD income.
Retirement Income Planning with Bartley Financial
Bartley Financial is built around a client-first ethos. We are as committed to exhibiting high levels of professionalism as we are to building relationships with clients built on trust and mutual respect. That’s why we hold ourselves to a fiduciary standard. It’s also why we offer a transparent, fee-only compensation structure, so that our clients never need to be concerned about a conflict of interest.
Bartley Financial has an experienced team of CPAs and CFPs® (Certified Financial Planners®) that help clients manage their investment portfolios, plan for retirement, strategize taxes, or execute any other initiatives in pursuit of optimum financial health and minimal financial stress. From our offices in Andover, MA and Bedford, NH, we work to ease clients’ financial concerns, strengthen their portfolios, and assuage their worry that they don’t know what they don’t know.
Contact us today to begin a relationship with a team of knowledgeable, trustworthy professionals who put their clients first.