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.