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.”