At first glance, required minimum distributions seem pretty simple. Using an age-based Internal Revenue Service table, an RMD amount is determined by the balance in the appropriate account(s) from Dec. 31 of the prior year.
This can make RMDs relatively straightforward. But for clients whose financial situation is more complex, there are some logistical issues surrounding when and how RMDs are taken during the year.
Timing of RMDs
Clients might ask about the best time to take their RMDs. The answer will depend upon their distinct situation.
If a client plans to use the RMD as part of a retirement income stream, taking the distribution monthly or quarterly might make the most sense. This way, the funds are connected to the time frame in which they will be used.
In other cases, it might make sense for clients to take their RMD all at once. Early or late in the year, or any time in between, this approach could be used to make an investment or allocate it as part of their taxable portfolio.
Distributions taken early in the year can keep things simple for beneficiaries in the event that a client dies during the year. This ensures that the RMD for the year of the client’s death was properly taken.
Advisors have differing opinions about when to have taxes withheld from the RMD. It often makes sense to have taxes withheld when distributions are taken. However, taxes on RMDs are flexible: They can be taken all at once at the end of the year if that makes more sense from a planning perspective.
Taxes and RMDs
RMDs taken from an individual retirement account, 401(k) or other traditional retirement plan will generally be subject to taxes at ordinary rates. It’s very common for clients to pay those taxes by having money withheld from each distribution — 20% is a common withholding amount.
A uniform tax withholding, or any withholding, might not be the right answer for all RMD distributions during the year. For clients with larger RMD amounts for the year, it can be beneficial to be more strategic about tax withholding during the year.
Many advisors suggest that clients defer RMD tax withholding until late in the year to simplify the process by not having clients make multiple payments. They can take the RMDs and allocate this money in a taxable account or put it to some other use without worrying about tax withholding.
RMDs are not subject to the same penalties for under-withholding as other types of income. Having a large withholding on an RMD at year-end can help make up for potential underpayments of taxes and potential penalties on other types of income during the year.
Distribution Bucket
The bucket approach to a client’s retirement savings allocation can make sense in many cases. One feature of this strategy is to have a low-risk bucket in the portfolio to hold money that might be needed over the next few years.
A low-risk bucket can be useful in IRA accounts for clients subject to RMDs. This can help ensure that some or all of the distributions can be taken without having to liquidate securities held in the account during a down market. This can also be a good source of funds for any tax withholding.
In-Kind Distributions
IRA and retirement plan account holders often liquidate shares to raise the cash for the RMD. For some, particularly high-net-worth clients, it can make sense to do in-kind distributions for their IRA into a taxable account.
This can entail taking a mutual fund, exchange-traded fund or individual shares or stock of a security whose price may be depressed and transferring those shares in-kind to a taxable brokerage account. This allows the transferred securities to appreciate inside the taxable account. If they are held in the account for at least a year, any capital gains will be taxed at long-term capital gains rates.
This strategy can satisfy several objectives. By using the in-kind approach, a client will not have the appreciation accumulate in the IRA. All else being equal, this can help reduce the level of future RMDs.
Consider a QCD ...
A qualified charitable distribution or QCD is one of the most powerful RMD planning tools for clients who are at least age 70.5. QCDs offer a tax-efficient way for clients to make charitable contributions, reduce future RMDs and help reduce a client’s tax liability arising from RMDs.
A QCD can be used to satisfy some or all of an RMD as long as the QCD is taken before the clients have satisfied their RMD obligation. The QCD is withdrawn tax-free, eliminating taxes on the portion of the RMD it was used to satisfy.
The money from the QCD goes to the registered charitable organization of the client’s choosing, providing a tax-efficient way to satisfy a charitable giving intent.
To the extent that QCDs are taken beyond any RMD requirements, they help reduce the amount of future RMD obligations. This money always comes out of the traditional IRA tax-free.
... Or a QLAC
Qualified longevity annuity contracts are a way to help ensure a lifetime stream of income and to defer RMDs on a portion of the money in a traditional IRA or other retirement account.Clients can use up to $200,000 to purchase a deferred annuity and can defer the start of payments as far as age 85. A QLAC can be a good option for clients who believe that they will have greater than average longevity and who have sufficient assets to allow for this deferral.
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