Calculating required minimum distributions from traditional IRAs, 401(k)s and other qualified retirement plans is pretty straightforward for those using lifetime expectancy tables from the Internal Revenue Service. But even if investors remember to take annual RMDs after age 701/2 (many don’t), they could use help preparing for and managing the process. This includes reinvesting RMDs they don’t need immediately for living expenses.
“When it comes to the RMD world, it isn’t as simple as ‘Here’s your RMD, now go take it,’” says Gerald Wernette, principal and director of the retirement plan consulting group at Michigan-based Rehmann Financial. “There are a lot of moving parts to be thinking about,” he says. These include complex rules, personal goals and state tax implications for wherever investors plan to reside during their retirement years.
The stakes of getting RMDs right are higher than ever. Baby boomers (10,000 of whom are turning 701/2 every day) are retiring with large deferred balances instead of the defined benefit plans their predecessors often had.
“Individuals retiring today, they’re an RMD generation,” says Maria Bruno, a senior investment strategist in Vanguard’s Investment Strategy Group in Valley Forge, Pa. But while retirees are thinking about RMDs more proactively, many still need help with the basics.
Her recent blog post about an RMD newbie—who learned the hard way (via an IRS penalty) that he had to take separate RMDs on his 401(k) and traditional IRA—received a flood of comments, many with questions. As she explained in her post, RMDs must be calculated separately and distributed separately from each employer-sponsored account. But RMDs for IRAs can be aggregated, and the total can be withdrawn from one or multiple IRAs.
The failure to take a required minimum distribution results in a penalty of 50% of the RMD amount. Individuals can postpone their initial distribution to April 1 of the year after they turn 701/2. Subsequent RMDs must be taken by December 31. If a distribution is postponed, two must be taken that year.
Wernette recently informed a plan participant over age 70 that he isn’t required to take a distribution from his 401(k) plan because he’s still working and owns less than 5% of the business (an IRS stipulation). Wernette also told him he can stop taking RMDs on any traditional IRAs and former employers’ 401(k) plans if he rolls them into his current 401(k) plan. Employees must contact their plan administrator to find out if the plan accepts transfers.
One of Wernette’s clients, an 84-year-old owner and sole employee of a law practice, didn’t need the RMD from his 401(k) profit-sharing plan for living expenses. He was able to contribute to the plan and deduct as much as he was required to pull out by the RMD. “The tax impact was a net zero,” says Wernette. However, he adds, “This is not going to work for the average employee.”
Often, “We end up really having a fairly dynamic conversation with a client because of all the possibilities they may have,” says Wernette. “People have options, and part of our job is to put those options on the table.”
Strategizing early is also important, say retirement specialists. “When you’re working, the last thing you’re thinking about is RMDs,” says Bruno, but that’s when the most options are available. During this time, investors can channel deferrals into a variety of account types—taxable, tax-deferred retirement and Roth (non-taxable retirement)—to ensure the most flexibility during retirement, she says.
With RMDs, “It’s not just how much to take, but from where, in terms of keeping the portfolio balanced,” she says. “You can look to see where you’re overweighted and then just take strategically.” Then there’s the frequently asked question about how to reinvest RMDs.
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According to a 2016 study from Vanguard, IRAs subject to RMDs had a median withdrawal rate of 4% and a median spending rate of 1%. For employer plans subject to RMDs, the median withdrawal rate was 4% and the median spending rate was 0%.
“I always say a mandatory withdrawal doesn’t mean a mandatory spend,” says Bruno.
The correct asset allocation for reinvesting RMDs really depends on an individual’s goals for those dollars, such as legacy planning or to create a reserve for later in life, she says. “But tax efficiency underscores all of it,” she says, “since you’re moving out of that tax-advantaged wrapper and into a taxable account.”
It’s important to be very strategic when considering tax planning opportunities, she says, and that’s where advisors can help. Roth conversions are always an option, but the distribution in the year of the conversion must still be satisfied, she adds.
As for asset allocation ideas, broad market index funds are low cost and very tax efficient, municipal bond funds can be appropriate for high-income earners, and equities—with their higher risk but longer time horizon—could play a greater role in portfolios for investors seeking to pass assets to heirs, she says.
Once RMDs are satisfied, advisors can help clients manage the income tax liability from those distributions. For instance, losses in a taxable account might be able to help offset the income from that RMD, says Bruno, and charitably minded investors can do a qualified charitable distribution (QCD).
Suzanne Shier, the director of wealth planning and tax strategy for wealth management at Northern Trust in Chicago, says many of her clients choose to do qualified charitable deductions and find it very helpful. Investors can opt to fulfill up to $100,000 of their annual RMD from IRAs by making a direct distribution to a qualified charity.
“Coming to the golden age of 701/2,” she says, is one trigger for RMD conversations. The other is inherited retirement accounts. Non-spousal beneficiaries are often surprised to learn they must take annual RMDs. Their exact start date depends on many variables, including the age of the decedent, but “they don’t have benefit of waiting until they’re 701/2,” she says. Spouses are permitted to treat inherited retirement accounts as their own.
Individuals who’ve had a death in the family during the year should take a close look at any retirement accounts they may be beneficiaries of and get some guidance on what the distribution requirements will be, says Shier.
When her clients are around age 50, she starts speaking to them about their retirement options and when they can take distributions (permitted and required) from their 401(k)s and IRAs. A very real concern for individuals, she says, is figuring out what level of withdrawals will be sustainable so income doesn’t exceed life expectancy. They need to factor in lifestyle decisions, such as whether they want to downsize the family home, she says.
When considering which accounts to take RMDs from, she encourages investors to consider fees, investment options and whether they want to consolidate multiple accounts. “Personally, I’m a ‘simple is better’ person,” she says. If clients leave their 401(k) assets in their former employer’s plan or roll it into an IRA, she double checks to make sure they have scheduled taxes withheld from their RMDs each year.
Shier’s clients don’t ordinarily think specifically about where to reinvest distributions received from 401(k)s or IRAs. “They would’ve created an overall investment approach that’s aligned with their goals,” she says, “and then they would slot this distribution into the sleeve that they are making additions to.”
RMDs create a big shift in assets for individuals over 701/2, with retirement assets declining and nonretirement assets staying steady or increasing. So she encourages them to frequently review not only who their beneficiaries are but how they’re being taken care of in their overall estate plan.
Gary Shor, a financial planner with AEPG Wealth Strategies in Warren, N.J., says some clients use RMDs to pay off living expenses or pay down high mortgages. Others use the distributions to fund their grandchildren’s 529 college savings plans. Whether the tax deferrals received on the 529 plan contributions offset the taxes incurred on the clients’ RMDs depends on their tax bracket, he says.
Sometimes clients opt to take in-kind distributions (taking the distribution in the form of the securities held in the retirement plan, rather than in cash), which they slide over to an institutional brokerage account, he says.
Individuals may also bump up their federal withholding tax on RMDs they take at the end of the year in order to make up for and avoid penalties for failing to pay enough in estimated taxes during the year, says Shor. “You can withhold up to 100% on RMDs if the custodian allows this,” he says. This strategy can be employed with RMDs from 401(k) plans, IRAs and inherited retirement accounts, he notes.
Education Efforts
Soltis Investment Advisors, a firm with offices in Salt Lake City and St. George, Utah, regularly offers readiness education to the participants of the qualified plans Soltis manages. These sessions cover RMDs, Social Security, Medicare and other must-know topics.
Plan participants are told they can direct their own RMD or that the plan provider will automatically calculate and distribute it if they don’t provide any direction. Typically, participants will direct it themselves, says Tyler Finlinson, the director of business development and a senior advisor at Soltis.
The firm holds proactive conversations with its wealth management clients about how to satisfy their RMDs requirement. Afterwards, “It’s never really a mystery to them of what it’s going to look like,” says Clark Taylor, Soltis’s vice president of wealth management services.
Retired clients typically roll their 401(k) plan into an IRA. Some have distributions pulled monthly or quarterly; others wait until year’s end in order to get more tax-deferred growth. Soltis runs tracking reports to make sure distributions aren’t overlooked. “If clients haven’t completed their RMD by early November, we’re all over them,” says Taylor.
Although many of Soltis’s wealth management clients need their RMDs to satisfy living expenses, more clients are starting to say, “I don’t really need this money. I hate to have it come out. What do I do with it?” says Finlinson.
The firm generally helps clients reinvest their RMD proceeds in a taxable account or, if someone has one, a revocable trust or a joint account with the rights of survivorship, says Taylor.
Participants in the 401(k) plans that Soltis manages can reach out to the firm for advice and assistance regarding reinvesting their RMDs. “Typically, when they get to that stage, we are eager to sit down with them and try and help them build/understand how they build an income stream from all their assets,” says Finlinson.
The firm also helps its many charitably active clients donate RMDs directly to charities so the proceeds don’t hit their adjusted gross income. “We also can take that a step further,” says Finlinson, by helping clients donate shares that have experienced big gains. This helps mitigate some tax exposure.
The bottom line: RMDs aren’t a one-and-done—and investors need continual help, even if they don’t realize it.