It’s going to be an unusual year for retirees. For example, in 2020 the required minimum distribution was waived, and the age at which retirees must begin taking RMDs was raised to 72 from 70.5.
Also, 2021 brings in a new administration and Congress, which might mean tax changes, as well as updates to Social Security and Medicare.
Christine Benz, Morningstar’s director of personal finance, recently interviewed Vanguard’s head of wealth planning research, Maria Bruno, and asked what retirees — and advisors — should watch for in 2021. Here are four of Bruno’s suggestions:
1. RMDs are back and must be taken yearly.
Due to the pandemic, required minimum distributions — intended to spread out a retiree’s savings, and the related taxes, over an expected lifetime — were waived in 2020. Also, the RMD age was raised due to the Secure Act, so those who turn 72 this year have until April 1, 2022, to take their distribution. Those older than 72 must take their RMDs by Dec. 31.
Bruno cautioned that the cost of not taking the distribution is significant: a 50% excise tax for the amount that should have been taken. Therefore if a retiree is mandated to take a distribution — “and again the distributions are from traditional IRAs, 401(k)s and Roth 401(k)s, although they are not taxed” — they are required to take withdrawals on an annual basis, Bruno told Benz.
2. Start thinking about withdrawal strategies before RMD age.
Bruno noted that retirees should think about RMDs as an “asset pool.”
Retirees under 72 who are withdrawing from IRAs and 401(k)s should consider this: “If [retirees] have flexibility in having taxable assets or tax-deferred or Roth assets, [they] can be surgical on a year-by-year basis to think about: How can I minimize both the liability this year, but then also what I might be looking at in the future?”
She added that “a lot of individuals are sitting on large tax-deferred balances, and while there is a benefit to not touching [those because clients can] continue to enjoy tax-deferred growth, some individuals, given the size of their IRA or 401(k), can be subject to pretty large mandated distributions, which would then come with what they call the ‘tax torpedo,’ — large tax liabilities.”
Leading up to age 72, retirees “could start to withdraw from those assets,” Bruno explained.
Withdrawals from those assets before age 72 may mean a higher tax rate now, but would reduce the RMD later because of the smaller amount in the IRA.
Another option is converting some of those assets to Roth IRAs, which are not subject to lifetime distributions, she said.
3. Taxes matter, so work with a tax or financial professional.
This is key because withdrawal strategies, including Social Security timing decisions, have tax consequences beyond RMDs.
4. The 4% rule isn’t dead, but be flexible.
She noted that in Vanguard’s long-term forecast, investment “returns are muted.” A projected median return is 4.5% with inflation potentially around 2.5% to 3%, Bruno said.
“That doesn’t mean the 4% rule is dead,” she said. “Just be mindful in terms of what conditions we’re looking at today and over the next couple of years; [retirees] might need to be a little bit mindful in terms of ratcheting back [spending] a bit.”
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