Ep. 161 – How Required Minimum Distributions and QCDs Work?

When it comes to taking your money out of your IRAs and 401ks after retirement age, you might need to understand the terms RMDs and QCDs.

At age 72, you’re required to start taking distributions out of your 401k and IRAs with a formula based on your life expectancy. The key here is to be tax-efficient or even go tax-free in any way you can without breaking the law.

In this episode of the Secure Your Retirement podcast, we take you through the Required Minimum Distributions and Quality Charitable Distributions. Listen in to learn how to save on tax by taking your money out of an IRA/401k and doing a Roth conversion if you’re 65 and retired.

In this episode, find out:

• The formula to calculate your distributions which you’re required to start taking based on your life expectancy.
• Taking out your RMDs in the year you turn 72 and the consequences of deferring your first RMD.
• Understand that you can withhold tax for RMDs plus the frequency in which you take your RMDs.
• Understanding how any pre tax asset that is subject to RMDs is calculated.
• Why take money out of your IRA/401k and do a Roth conversion if you’re 65 and retired to save on tax.
• Where to take the RMD money from when you have several IRAs and 401ks.
• Quality Charitable Distributions (QCDs) – qualifying to take your IRA money tax-free at age 70 and a half.
• How to avoid paying tax or doing it efficiently on your RMD through the QCD strategy.

Tweetable Quotes:

• “At age 72, you’re required to start taking distributions out of your 401k” – Radon Stancil
• “It’s perfectly legal to defer your first and only RMD, after that, it must be all completed by 12/31 of the calendar year.”– Murs Tariq

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Hers’s the Full Transcript:

Radon Stancil:	Welcome, everyone, to the Secure Your Retirement Podcast. Murs and I are certainly happy that you want to spend a little bit of time with us on our podcast. Today, we’re going to talk about a topic that is something that might not apply to you today, but it will apply, and you might want to start thinking about it and having a strategy to deal with it before you get to the age where it’s needed.
	What is that? Required minimum distributions. So this is in the context of a traditional IRA or a 401(k) or any company plan that you might have. And they have a lot of different things out there. There’s SEPs, S-E-P’s, there are 403(b)s, 457s. Anything where we defer our taxes into the future, the government, at some point, says, “Hey, you’ve got to start taking distributions out of there.” And they’re called required minimum distributions. We call them RMDs. So we’ll refer to that throughout the conversation today, RMDs, required minimum distributions. We’re also going to talk a little bit about QCDs. And so Murs will kind of go into that a little bit in our conversation.
	So first of all, let’s just talk a little bit about why would the government say you’re required to take distributions? Well, let’s just think about what you have done. When you put money and you defer the tax, you put the money in without paying taxes into a retirement plan, traditional IRA, 401(k), or anything like that, you basically are making a deal with the government. And the deal is this. “I don’t want to pay your taxes now, but I will pay you later.” And the government says, “We know you’re going to pay us later because we’re going to make you take distributions out.”
	So the way that looks is, it used to be age 70 and a half, and then it got changed. And now it’s at age 72. But at age 72, you are required to start taking distributions out of your 401(k). And there is a formula on that and it is based on your life expectancy. Your life expectancy, it’s not based on you as an individual. It is a very generalized life expectancy table that the IRS puts out that you can get access to. And I can tell you, at age 72, the government says that you have a life expectancy of 27.4 years. So what do you do with that? Well, you take your balance and you divide it by the 27.4 and you’ll get what your distribution is.
	You are using your balance from December 31st, and I’m going to have Murs kind of go through some of the dates and how we come about this. But if you take your balance on December 31st of the year prior of when taking the distribution. So let’s take this year, for example. It’s 2022. If I wanted to know what my distribution would be, I would have to look and say what was my balance on December 31st? And then I have to take the distribution based on that balance. Now, depending on how you’re invested right now, your balance could be lower today than it was on December 31st because the stock market’s been down. You still, though, cannot use the current. You have to use what it was on December 31st.
	So let’s pretend that on December 31st, my IRA had a $500,000 balance. Even. I would take 500,000, I would divide it by 27.4, and then that’s going to give me my distribution amount, which is $20,242.91. I’m required to take that out. Now, you might say, “Yeah, but I don’t have to take it out in the year of 72.” So Murs, can you tell us how that rule works of when am I required to take that first distribution, because there’s a couple rules that we can go back and forth on that.
Murs Tariq:	Yeah. So only on the first distribution is there a little bit of leeway. So the rule is, in the year that you turn 72 is the year that you’re going to have to start taking required minimum distributions. On that point, by the way, sometimes people think, “Well, if I turn 72 this year but it’s in November of this year, do I have to wait until November of this year to start taking my distribution?” No, it’s the year in which you turn 72 is when the requirement starts. So even if you turn 72 in November of 2022, you can actually start taking your distribution in January of 2022 because it is in the year when you turn 72. So to get that out up front.
	Now, the one-time deferral that you can do basically is in your first year. So say you’re turning 72 in 2022. And you say, “I would like to have another option around when to take this RMD.” There’s a one-time deal where you can actually essentially delay your first RMD into the next calendar year. So in this case it would be 2023. And you have to take it by April 15th-
Radon Stancil:	April 1st.
Murs Tariq:	April 1st, by April 1st. Yes. So pros and cons around that. We want to think these through. If you decide, “No, I’m going to wait until April 1st of 2023 now,” think about this. Now you have to take what is essentially your 2022 RMD in calendar year 2023, but that doesn’t get you off the hook for the next year. So basically you’re doubling up RMDs in calendar year 2023. The one for 2022 and then also for the year of 2023.
	So go to Radon’s example of you have to take roughly about $20,000 out for your first RMD and you decide to defer it into the next calendar year, well, basically you’re signing up to say that you’re going to take out 40,000 in 2023 versus splitting it up over two years. So just something to think about. You do have that option. It’s perfectly legal to defer your first RMD and only your first RMD. After that, it must be all completed by 12/31 of the calendar year. So honestly, we don’t have a lot of clients that do that, but there are special situations where it could work out.
	Now, go back to my situation of, we get the question all the time. How should I take it and when should I take it? Can I have taxes withheld? I’ll answer all of these. Yes, you can have taxes withheld. I would say actually the majority of our clients are doing tax withholdings on their RMD distribution. So you can withhold federal tax as a percentage. You can withhold state tax as a percentage. That way you don’t have to worry about doing quarterly payments or getting a surprise when it comes tax time of next year. But we also have clients that are completely comfortable doing the quarterlies. And so that works for them too.
	As far as the frequency of distribution, remember it’s the year in which you turn 72, or it’s in that year. So you can take, let’s say it’s a $20,000 RMD that you have to take in the calendar year of 2022. You can actually take it on a monthly distribution. So that’s kind of in that 12… what is that, less than $2,000 a month that you’re taking out if you want to have like that standard monthly paycheck. A lot of our clients like having that monthly paycheck. As long as by the end of the year, you’ve taken out the full RMD amount.
	So Radon walked you through the calculation. And a lot of times we get the question of, “Hey, do I need to know how to do this calculation?” It’s very good information for you to understand it and how it works, knowing that it’s based off of a balance on 12/31, knowing that there is a table. But every institution is going to provide this for you. If you have your investment accounts at Schwab, or your 401(k) provider, or through an insurance company, any pre-tax asset that is subject to RMDs, the custodian, the company that is holding the asset, is going to do the calculation for you. Why? Because the IRS is going to rely on them to report how much that you need to be taken out. So we always say, yeah, you can do your calculation if you want, but really go off of what the institution is providing for you, because that is the same required number that they are reporting to the IRS. So those are just a few things there. Anything else on RMDs, Radon?
Radon Stancil:	Well, I was just going to say, sometimes people think, “Well, I’m going to wait until my requirement of my distributions are due.” And it might be that if you’re 65, let’s say, and you’ve retired, that it would be good for you to go ahead and start distributions prior to 72. Well, why is that? Well, it’s kind of really around this idea of a tax strategy. Now, if you say, “I don’t need the money,” well, then we can still take it out and do a Roth conversion. So what we would do is take out some money from your 401(k), your IRA, however that may be, and I would just do a conversion and get it into a Roth.
	Well, why would I do that? First of all, I get to pay taxes at whatever the tax rate is right now. And if I can do that at a lower range, that’s good. And I don’t have my IRA continuing to grow at such a pace that I’m going to have this huge RMD come out at 72. The other thing is, now, so I’ve reduced my future RMDs by doing what we kind of say is a smoothing or a leveling there on those distributions, as well as now I’ve got a chunk of money that’s growing tax-free over in my Roth. So that can be a huge strategy. And I would tell you that if that is the case and you’re not 72 yet, talk about that with your advisor. Make sure you have a conversation around, “Hey, is it a good idea for me to start taking some money out of my 401(k) or IRA prior?”
	The other thing I just want to mention is that let’s say that you have five, and I’m just using a number, IRAs. You can then take the number of all five. So let’s say I go back to my $500,000. Let’s say I had a hundred thousand dollars in each account and I have five accounts. So I got 500,000. I do not have to take the required minimum distribution from each individual account. I can say I’ve got 500,000 in IRA money, and I can take that $20,242.91 from just one of the accounts. The IRS does not care as long as I just do the computation.
	But now what if I have four IRAs and one 401(k), a hundred thousand in each, and one of those is a 401(k)? Well, the IRS says in that case, I have to take the required minimum distribution from the 401(k), whatever portion is there needed. So what I would do is, the number doesn’t change, but I would take the portion though of that 401(k) and take that amount out of the 401(k) and then the rest of it out of the IRAs. I cannot combine those two in the calculation. So just keep that in mind. I cannot take it out of the 401(k) from other accounts. I have to take it from that individual account. Now, we want to just talk a couple of minutes about a great strategy around what are called QCDs. So Murs, can you tell us what a QCD is and the power of utilizing that?
Murs Tariq:	Yeah, so it’s actually, we had a very relevant conversation with a client a few weeks ago on this topic. QCD stands for a qualified charitable distribution. And the way that it is utilized is actually, and the IRS loves their different ages. We’ve got 72 for RMDs. For QCDs, you actually can qualify to utilize this feature at age 70 and a half or older. Age 70 and a half or older. And it’s in the name, charitable distribution. So if you are giving to an organization, maybe a charity or a religious organization, anything that is a qualified charity, then you actually have the ability to use your IRA money and create this distribution that goes directly to the organization and not pay taxes on it.
	So let me go to the scenario of the client that we spoke to. The client that we spoke to, they’re an RMD age. So they’re above 72, and they don’t need their RMD. So what they’ve been doing currently is they were just taking the RMD that they have to take out, paying the taxes on it. And then once that money hits their bank account, then they are writing a check to their various charities that they feel inclined to give money to. And while they don’t need the RMD, so this made a lot of sense in their minds that, “We don’t need the RMD but let’s just go ahead and give it away.”
	While we think that’s a fantastic idea, if you’re charitably inclined, that’s great, but let’s make sure that we’re doing it in the most efficient manner. So enter in now this QCD concept. Qualified charitable distribution. What we’re changing with the client is, rather than them taking the distribution to themselves, paying the taxes on it to themselves, and then writing a check out of their bank account to the charities and the organizations, we’re skipping a step. And essentially, that step that we’re skipping is paying the taxes on that money.
	So let’s go to an example of you have a $20,000 RMD, and you want to give 10,000 to one charity, you want to give 10,000 to another charity. Well, rather than taking it in your hands and in your pocket in your bank account, what you can do is this qualified charitable distribution, which essentially you take the money, the $10,000 amounts, and you have your custodian, your investment account, cut the check directly to the charity. So it’s paid to the charity. It never enters your hands. And it is delivered directly to the charity.
	What that does is essentially erases the taxes on that amount. So in one case, you’ve got a $20,000 taxable distribution and maybe 20% of that or so is going to go to taxes. Now, in this scenario with the QCD, you have a $20,000 tax-free distribution directly to charities. So a massive, massive scenario change all by knowing, it’s not any product or anything like that. It’s all just knowing a little bit about the tax code and how we can use the tax code proactively to make our scenarios a little bit better.
	We think giving to charity is great. If you’re inclined to do that, that’s great. Let’s make sure we do it in the most tax-efficient manner. Which ideally, if you’re going to give to charity, there should be some benefit from a tax perspective, let’s do it tax-free. So the QCD is very, very powerful. We’re talking to clients about it all the time. Again, that’s if you’re age 70 and a half and above, you can do that. We’re happy to chat with you. There are some specific steps as to how to accomplish it. So we don’t want to get it wrong. We want to get that tax benefit. So we’re happy to chat and hop on a phone call with you and help you understand the best way to do it.
Radon Stancil:	All right, we hope this has been helpful. We know we went through a lot of numbers. Go to the website, pomwealth.net. Go to the blog page. And you’ll see an article that we have written on this very topic, has all the numbers that we went through, all those rules and guidelines so that you can see exactly how that works. Have it there in writing right in front of you.
	Also, wherever you’re listening to this, we always ask, go ahead please and follow us, subscribe, however the scenario is there for you, and write us a review. We’d certainly appreciate it. Also want to tell you that we have something that you might want to check out also on our website. If you go now to a new tab called Weekly Updates, Murs and I, every single Monday, we put out a weekly update really around the market and commentary around the market in addition to this podcast. So check that out if you’d like to know a little bit more about what we do there.
	We are glad to always hop on the phone with you as well. So please, if you would like to do that, you can go to the website, go to the top right-hand corner, click on complimentary phone conversation. And we would be glad to have a conversation with you around any topic you have around retirement or getting ready for retirement. We’re really eager. We always love to be able to talk to people about how that can affect them in their life. But anyway, thank you very much for listening. We will talk to you again next week.