The Case for Supersizing RMDs

by Prof. Robert Bloink and Prof. William H. Byrnes

Typically, advisors focus on ways to help clients reduce their required minimum distributions (RMDs) from retirement accounts. For many, reducing RMDs and taking only the bare minimum each year can go a long way toward reducing the client’s overall tax liability for the year. On the other hand, the size of a client’s RMDs shouldn’t be considered in a vacuum. In some cases, it might actually make sense for the client to take RMDs that are larger than required in a particular year—and many think that 2021 could be one of those years for a wide variety of clients.

RMDs: The Basics

As most clients know, the RMD rules set a date after which a retirement account owner must begin taking withdrawals from the account. For 2021, RMDs apply to anyone who was at least age 72 years old by the end of 2020 (prior to 2020, the required beginning date was age 70 ½). Under normal circumstances, clients who turned 72 in 2020 would have to take two distributions by December 31, 2021—their 2020 distribution, which is due by April 1, and their 2021 distribution, due by December 31.

The CARES Act waived all RMD obligations for 2020 in response to the COVID-19 pandemic.

RMDs for any given year are calculated based on the account value at the end of the prior year—meaning that 2021 RMDs are calculated based on the account values as of December 31, 2020. Many account balances have the potential to be higher if the client skipped 2020 RMDs.

While clients can’t take less than their annual RMD, they are permitted to take larger distributions without any penalties.

The Case for a Larger RMD

Clients often take the bare minimum RMD required in order to leave more funds to grow tax-deferred and minimize taxable income. However, the 2017 tax reform changes may present an opportunity for clients to take higher RMDs without jumping into a higher tax bracket. Clients should consider a few different factors when determining the size of their RMD: their current tax rate, anticipated future tax rates, and the tax rates of intended beneficiaries.

For example, in 2022 a married couple is taxed at 22 percent for income in excess of $83,550—and won’t jump into the 24 percent tax bracket until income reaches $178,150. Some clients may wish to “fill up” that 22 percent tax bracket to take advantage of historically low tax rates. That’s especially true if they believe the Biden administration’s pending legislation will eventually increase income tax rates in future years.

Married clients should also consider age differences between the spouses. If only one spouse is required to take an RMD in 2021 and a second spouse will be required to begin RMDs in 2022, it could make more sense to take a larger RMD in 2021—and two smaller RMDs (based on a lower account balance) in 2022. Basically, the larger 2021 RMD could help reduce RMDs in 2022 and future years if the clients are no longer contributing to the IRA.

Clients should also consider the tax brackets of their intended beneficiaries when taking a larger than anticipated RMD. For older clients, if the intended beneficiary is in a high-income tax bracket, taking a larger than needed RMD could reduce the beneficiary’s future tax liability—and overall tax liability if the account owner is in a lower tax bracket.

The Medicare Premium Planning Trap

Of course, an increased RMD will increase the client’s taxable income for all purposes. That can create a headache for clients when determining their Medicare premium costs.

Medicare income-based surcharges, or the income-related monthly adjustment amount (IRMAA), are determined based on a sliding scale that uses the Medicare recipient's modified adjusted gross income (MAGI).

Clients in higher income tiers have higher Medicare premium costs. Unfortunately, the system bases those IRMAA surcharges on the client’s income from two years ago. So, the client’s Medicare premiums for Part B and Part D in 2023 would be determined based on the client’s 2021 income—which could be higher if the client takes a larger than required RMD.

Conclusion

Every client’s situation is unique. For some clients, that means taking larger than required distributions in low-tax years as part of a larger tax planning strategy that can save money in future years.