Financial advisors say that there are ways to satisfy required minimum distribution requirements efficiently, so that the legal requirement works to a client’s benefit.
Distributions from individual retirement accounts and other qualified plans have to begin when the owner turns age 70-1/2 or after a spouse of beneficiary inherits a qualified investment.
But satisfying the tax law can also be used as part of a strategy to make a client’s retirement portfolio more efficient, say planners.
For instance, while RMDs are required on the total amount of all IRA accounts held by a client, that total can be taken from any account or combination of accounts, according to Warren Ward, a certified financial planner with Warren Ward Associates, Columbus, Ind.
An advisor can recommend that the RMD be taken from the “least suitable account, perhaps an IRA annuity with lots of internal costs and significant surrender charges,” he says. The reason, Ward explains, is that charges are usually waived in the case of RMDs.
When a client turns age 70-1/2, an RMD can be taken that year or by April 1 of the following year, points out Jeremy Portnoff, a certified financial planner with Portnoff Financial LLC, Westfield, N.J. But if the RMD is delayed until the following year, another RMD must be taken for that year, for a total of 2 RMDs, he says.
Consequently, a client’s income in the following year and the possible tax consequences if the client is pushed into a higher tax bracket must be considered before a decision is made, Portnoff says. If the client is pushed into a higher bracket, more of the client’s Social Security benefits may be taxable, he says.
“There is a nasty interplay of RMD and Social Security payments that can affect clients whose primary income is Social Security and medium-sized IRAs,” says Tom Davison, a certified financial planner with Summit Financial Strategies, Columbus, Ohio.
The interplay, he explains, is when single clients are pushed into an effective marginal rate of 46% for federal taxes and married couples who file jointly end up in the 28% tax bracket rather than the 15% bracket.
But one good tax planning feature about the RMD is that the client can withhold any amount needed for tax purposes from the IRA distribution, Davison says.
“For example, you could do a $1,000 distribution, and have the entire amount withheld for federal taxes. So you would receive $0 in your hands, but the Internal Revenue Service (or your state) would receive $1,000,” he says. “The entire $1,000 counts towards your RMD, whether none, some, or all is withheld.”
In fact, he says, withholding is more useful than doing estimated tax payments. That’s because withholding can happen any time in the year, but estimated tax payments are matched up with income during each quarter, Davison explains. “So withholding can get you out of an under-withholding penalty that an estimated tax payment can’t.”
With some clients, his firm schedules IRA distributions later in the year, to see if there are sufficient tax withholdings or whether additional holdings are necessary so clients will be “penalty-proof for that year.”
Davison notes that he recently handled a client’s distribution from an inherited IRA in which he had 100% of the distribution withheld for federal taxes.
Other suggestions offered by Davison include withdrawing investment advisory fees directly from IRAs, allowing clients to remove funds without paying taxes and reducing future RMDs because the account values will be smaller.
And, Davison says, an advisor can consider distributing assets in kind from an IRA to a taxable account, avoiding the need to sell the asset and then buy it back again and receive a commission charge as well as being out of the market for a period of time.
Frank Boucher, a certified financial planner with Boucher Financial Planning Services, Reston, Va., raises the issue of liquidity within an IRA or a qualified plan. There has to be enough liquidity to meet the RMD requirement, he says. Maintaining sufficient liquidity, he explains will help prevent the need to sell assets at a loss.
A liquidity problem can be avoided, he says, by having the client start to accumulate cash inside the IRA, a few years before the RMD starts; this cash can then be used to pay for the RMD. This can be accomplished by having dividends and income of stocks and bonds and mutual funds in IRAs paid to the IRA instead of being reinvested, Boucher says.
Another way to prepare for the requirement would be to “systematically redeem securities or mutual funds over a period of years,” he says.
The RMD requirement may reduce the need to spend other taxable assets, he adds.
The amount of RMD taken each year can vary depending on the client’s age and the value in the IRA or qualified account, notes Dawn Brown, a certified financial planner with L.J. Altfest & Co., New York. For instance, a down market actually reduces the amount required to be taken from the account, she says.
Another point worth noting, according to Brown, is that if there is a beneficiary IRA with more than 1 beneficiary on the beneficiary form, the client needs to write down the percentage allotted to each beneficiary. If this is not done, it will be assumed that the total will be divided equally among the beneficiaries, she says.
Each beneficiary is then able to roll over their portion into their own inherited IRA with their own life expectancy as the basis for distribution, she explains. But if the account does not specify shares, Brown says, then the oldest beneficiary’s age is used, a choice that is not optimal for the youngest beneficiary, she notes.