Financial advisors say there are ways to efficiently satisfy required minimum distribution rules that can even make the legal requirements work to a client’s benefit.
Distributions in IRAs and 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.
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, explains 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 two, he adds.
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, he adds. If the client is pushed into a higher bracket, more of that 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, comes when single clients are pushed into an effective marginal rate of 46% for federal taxes and married couples that are filing jointly end up in the 28% tax bracket rather than the 15% bracket, he continues.
One good tax planning feature about the RMD, however, is that you can withhold any amount needed from the IRA distribution, Davison explains. With some clients, his firm schedules IRA distributions later in the year to see that there are sufficient tax withholdings or whether additional holdings are necessary so clients will be “penalty proof for that year.”
In fact, Davison notes that he recently handled a client’s distribution from an inherited IRA in which 100% of the distribution was 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., also raises the issue of liquidity within an IRA or a qualified plan noting that you have to have enough liquidity to meet the RMD requirement. Maintaining sufficient liquidity, he explains will help prevent the need to sell assets at a loss.
By starting to accumulate cash in the IRA to pay for the RMD, a few years before the RMD starts, a liquidity problem can be avoided, he says. 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 continues. Another way to prepare for the requirement would be to “systematically redeem securities or mutual funds over a period of years,” he adds.
The RMD requirement may reduce the need to spend taxable assets, thus reducing unneeded taxable income, he adds.
And the amount of RMD taken each year can vary depending on the client’s age and the value in the IRA or qualified account, according to Dawn Brown, a certified financial planner with L.J. Altfest & Co., New York. So a down market actually reduces the amount that is required to be taken from the account, she explains.
Another point worth noting, according to Brown, is that if there is a beneficiary IRA with more than one beneficiary, on the beneficiary form you need to write down the percentage allotted to each beneficiary or it will be assumed that the total will be divided equally among the beneficiaries.
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 situation that is not optimal for the youngest beneficiary, she notes.