April 8, 2016

My IRA and My RMD - What?


I learn something new every day, when I am paying attention. In this case, the knowledge will help me, and maybe you, reduce what the IRS grabs.

I thought it best to take money out of my IRA, only when the law forced me to - at age 70 1/2.  Because of income from my parent's estate, I don't really need to tap into those funds for several years. Let it continue to grow, tax-deferred, for as long as possible. Sounds reasonable.

Well, maybe not. While delaying taxes on whatever monies are in a regular IRA, SEP, 401(k) or other similar investments is usually the goal, at some point the government wants their cut. That is when something known as the Required Minimum Distribution, or RMD, comes into play. 

I am aware of the RMD and knew that in five years it would begin to affect me. Recently, though, I have learned that I am better served by taking money out of my personal IRA before I am forced to. Why? Tax savings.

Caution: I am not a financial advisor so what I am describing comes from my advisor, for my situation. However, she and others note that this strategy is something most folks should at least consider. 

In 2020, I will have to start utilizing the RMD tables. For tax purposes, they project I will live another 27.4 years. A doctor would probably tell me I have another 15-20 years, but the IRS is a little more forgiving. In any case, at that point, I must divide the total amount in my personal IRA that existed on December 31st of the previous year by that 27.4 figure. The result is my RMD, the amount I must take out before the end of the calendar year. 

If I don't start withdrawing before then, the amount in the IRA will continue to grow. Obviously, that means the required minimum distribution will be higher because the total in the account is larger. That could easily push me into the next tax bracket. By allowing the account to sit, untouched, for another 5 years, the larger amount required for an RMD distribution could also mean I may have to pay more taxes on a bigger portion of my Social Security income each year.

Because I have a beneficiary IRA from my father's estate that also has an RMD, the combination of both IRAs would mean I'd be forced to accept more money each year than I really need to live on. Sure, I can reinvest what I don't need but the tax bite has already been taken. And, I will pay taxes again on any investment growth. I could also open a ROTH IRA, which has no RMD requirements, but that doesn't avoid the original tax bill.

So, I have been urged to begin tapping into my IRA now. Yes, I will still pay taxes on that withdrawal, but I have a bit more control over its effect on my tax bracket since the amount I take out is determined by me, not the law.

All this sounds somewhat counterintuitive and confusing, but the rational makes sense. If I have to pay taxes on what I have been putting away since my early 30's, I would like to have some control over the timing and damage.

Live and learn.


26 comments:

  1. Thanks for that information. I have been holding back withdrawing from my 401's for the same reason you did. Looks like I am going to have to change strategy. Keeping an eye on "tax brackets" is something I have done more of since I retired two years ago next week. One way or the other, the government will get their taxes.....except if we were in the top tax bracket or if you and I could "shove" those funds down to that Panama financial office. :)

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    1. Avoid Panama, Steve, except for a vacation or trip through the canal.

      Luckily I told my advisor my plans; she stopped me and suggested the approach detailed in this post.

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  2. Well, this is a good problem to have. But I think you (or your tax adviser) is probably right. I have found that it's better to take out taxable money in dribbles and drabs, as much as possible, rather than taking out lump sums and getting hit by a big tax bill. Also, it's more likely that taxes will go up rather than down over the next 5 to 10 years, so the tax you pay now may be less than what you pay later..

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    1. Rising taxes seems to be a safe bet. That's another reason to withdraw while I still have some control and knowing that no one raises taxes in an election year!

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  3. Makes good sense that control should be part of the strategy. We did that with one tax-deferred account several years ago, and although the tax costs turned out to be about equal to those had we waited, the sense of security when we gained control of the funds has proved to be valuable.

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    1. Frankly, I don't know how much I will save under this approach. But, as you note, I feel better creating the timetable rather than leaving it completely in the hands of a tax table. I will admit, however, I want to thank the IRS for telling me I am likely to live to 97 !!

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    2. Couldn't you take
      the money out and purchase a deferred annuity? Charitable gift annuity. You might get a tax deduction. It's part of my plan with some stocks I own.

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    3. I will look into that, Gail. Thanks for the suggestion.

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  4. I figured this out quite some time ago....but then I was an accountant (not a CPA or tax accountant) for 40 years. I am taking out as much each year as I can without having to pay much more in taxes. Right now, I have to keep our income at a certain level to keep our health insurance cost down, (I am 63 and my husband is 62), but will increase the amount we withdraw when we are both on medicare. My goal is to pull as much out of the IRA as I can at lower tax rates before I pass away, so I don't leave a large "inherited IRA" to my daughter that she will have to pay taxes on, but instead leave her tax-free money. My mother passed away last year and I received half of the money in an "Inherited IRA", which I appreciated, but directly affected my tax planning. I am more thankful for the amount I received tax-free! Putting the additional amount that you don't need into a non IRA account gives you much more freedom....you will have the non-taxable cash for big items that might hit in retirement, like a new roof, a huge medical bill, a new car, etc. Leaving everything in the IRA means that if you need the money, you would have to pull out not only what you need, but enough for a huge tax bite as well.

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    1. It is good to have the input from a professional. Thanks, Donnine.

      The beneficiary IRA I received from my dad's estate was rather small, after being split among three sons. But, it does affect how I do things over the next few years.

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  5. The March 2016 AARP Magazine published an article titled "Keep More of Your Savings" by Eileen Ambrose.

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    1. That was the trigger for this post! Betty read it and suggested I write my own version. Sharp eyes, Joanne.

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  6. Under the right scenario what you are posting is correct, Bob. But as you posit, each person has to look at their own situation. Not all situations will be as generous.

    During 2015 I moved $ from a traditional IRA to a Roth IRA. When I was doing my taxes I realized that the amount I would be paying in taxes on that transfer did not make it worthwhile for me, so I recharacterized the $ back to a traditional IRA in March 2016 before filing my taxes. I will probably try this approach again of transferring during 2016 and see if the situation has gotten better due to a change in deductions and/or other items. As we stated, each person has to do their own due diligence to determine if paying the tax now is better than continuing to defer it until 70-1/2.

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    1. I am glad you emphasized that key point, Chuck: the situation described in this post is my situation. That being said, everyone can benefit from a review to see what is best for him or her at this time, and then as tax laws change (because they do!).

      Due diligence is the key and it should be performed by the individual, not just an adviser or blogger.

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  7. What do you think of taking out that money from your T IRA and move it to a Roth IRA to shelter it for your kids? We did that with most of my husband's TIRA before he started his SS. We did not need the money- so making it a Roth made sense. ~Janette

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    1. Except for the very big tax bill all at once, that is a possibility. Thanks, Janette. I will look into it.

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  8. I have been converting some of my traditional IRA to a Roth IRA every year. This works well in my situation. The amount is different each year according to my other income.

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    1. That ties in with Janette's suggestion above.

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  9. Wow, Bob, that was very enlightening! I had really considered the tax consequences of letting that IRA grow and grow. I'm fairly certain our financial advisor will know that sort of thing, but it was helpful to at least put the concept in my head before I need it! Thanks!

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    1. WE are taught to allow compounding and investments to work their magic. But, eventually we must pay the piper!

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  10. this is a timely article for me...I just received a letter from my mother's attorney stating that I could roll over money from her annunities into my established IRA...in talking with a financial advisor he informed me that I needed to establish a beneficiary IRA. I called the attorney and he said, oh, I guess I was wrong then. When I was speaking with the financial advisor, I told him I hoped to continue working past 70 1/2 and would be able to continue adding the maximum allowed to my 401k and that I would not have to that RMD from it until I stopped working. He said, no, you do have to begin taking them even though you are working...the article that you mentioned in the March addition of AARP was just e-mailed to the financial advisor this morning. I am very frustrated...I know these 2 men did not intentially give me bad advice, however, I no longer trust their advice and don't know who to consult that I can trust. I want to have someone I can trust when I am 85 and possibly dealing with demntia and knowing that I have competent folks looking out for me as the laws change and I'm not in a position to keep up with them. In the above scenio I was able to find out that they were wrong before it impacted me...these are 2 gentlemen professionals who should know better and don't seem to keep up with the basics. S C A R Y !!!!

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    1. My rule of finances: trust but verify. I have had the same adviser for 20 years. His advice has been good, except when it isn't. He has come up with a few stinkers that I should have performed some due diligence before I said, OK.

      I learned about a Beneficiary IRA when my dad died last year. I must withdraw a certain amount each year, but can base it on his expected life expectancy even though he is deceased. The IRS is giving me over 10 years to close it out. I won't take that long, but it is interesting that as an inherited asset I can continue to withdraw the money over a period of years.

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  11. I also have a Beneficiary IRA. I am taking it out based on my life expectancy - but the IRS table for life expectancy for an inherited IRA is different than a traditional IRA. I am only taking the required amount so it will last a long time.

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  12. Is there a table where the IRS shows how long they estimate people will live, for the RMD calculation?

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    1. Yes. Type "RMD calculation" in Google and all sorts of choices will be available.

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    2. Yes. Type "RMD calculation" in Google and all sorts of choices will be available.

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