We do love it when someone refers a family member or friend to us. Sometimes the question is, “How can we introduce them to you?” Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.
Here are this week’s items:
Portfolio Update: Murs and I have recorded our portfolio update for October 16, 2023
This Week’s Podcast – Required Minimum Distributions in Retirement – Monthly, Quarterly, or Annually?
Listen in to learn the advantages and disadvantages of taking required minimum distributions monthly, quarterly, or annually. You will also learn how the three-bucket strategy income safety and growth buckets can work together to your advantage.
This Week’s Blog – Required Minimum Distributions – Monthly, Quarterly, or Annually?
US tax law requires you to take a certain amount out of your traditional retirement accounts or employer-sponsored retirement plans each year, called a required minimum distribution. If you transferred money into these qualified plans and didn’t pay taxes on it, guess what? The IRS will eventually want you to pay your taxes, which is where RMDs come into the equation…
Required minimum distributions (RMDs) become a very important point of discussion before the end of the year, and there is a lot that you need to consider. You can take your RMDs monthly, quarterly, and annually.
However, which one is the right choice for you? That’s what we’re going to cover in this post. If you would rather listen to this post, we do have a podcast on this very topic.
What are RMDs?
US tax law requires you to take a certain amount out of your traditional retirement accounts or employer-sponsored retirement plans each year, called a required minimum distribution.
A traditional account is a tax-deferred account, such as your:
IRA
SEP IRA
401(k)
403(b)
457
If you transferred money into these qualified plans and didn’t pay taxes on it, guess what? The IRS will eventually want you to pay your taxes, which is where RMDs come into the equation.
Basically, you need to take out “roughly” 3.5% of your money each year, but there is a more complex calculation involved that we won’t go into with this post. The most important thing is that you’re required to take these distributions even if you don’t need the money.
Whether you’re in your 50s or 65, it’s important to educate yourself on RMDs and what you are required to do. Developing a plan for your RMD is important because you can incorporate a few strategies to lower your distribution requirements, too.
If you reach a certain age, you must take distributions.
In 2020, once you had reached age 70.5, in the calendar year, you would have needed to take distributions. After the Secure Act, this age has changed to age 73 – 75, depending on your birth year. The year you were born dictates this age:
Born in 1951 – 1959, your RMD age is 73
Born 1960 and later, your RMD age is 75
In the first year, you can defer your distribution to the next year and take it by April 1st. However, if you do this deferral, you will need to take two distributions, which is uncommon because it will push your tax bracket up.
On a Roth IRA, you have a tax-free bucket that you can use with no RMD requirement during the life of the original owner. Roth accounts are something that we often recommend as a strategy for eliminating or reducing RMDs, but this is something we’ll dive into more shortly.
Quick Note: Inherited IRA accounts work a bit differently. You used to be able to take distributions over a lifetime. Now, the new rule requires you to deplete the entire account over 10 years. There are a few caveats to this rule, but you’ll want to sit down with a financial advisor to discuss these in greater detail. Exceptions do exist for disabled individuals, minor or chronically ill beneficiaries and those who are less than 10 years younger than the original account owner.
Penalty for Not Taking an RMD
We do want to mention that when researching RMDs, you’ll learn that there is a penalty for not taking your distribution once required. The penalty can be 50% of the distribution, which is a lot, but we have never actually seen this applied.
Often, the government will give you a reprieve, but they do want you to take your RMD.
Is It Better to Take Your Required Minimum Distributions Monthly, Quarterly or Annually?
You know what RMDs are and that you can be penalized for not taking them, but one question still remains: at what frequency should you take your RMDs? We’re going to walk you through each of these distribution options.
Everyone has their own line of thinking when it comes to taking their RMDs, and it’s ultimately up to you. Each option has its advantages and disadvantages.
Monthly RMDs: Advantages and Disadvantages
Monthly distributions offer consistent cash flow – just like a paycheck. For example, if you need to take $12,000 per year in distributions, you can rely on $1,000 a month coming into your account.
You also benefit from market volatility.
For example, you are withdrawing the $1,000 when the account is up or down for the month, which can be an advantage or disadvantage. If you have a consistently down market when you’re withdrawing, that can become an issue.
The main advantages are:
Monthly cash
Less concern about the market
Easier to maintain a budget
However, the disadvantages are almost the exact opposite of the advantages. You’re taking money out of the account and missing growth opportunities.
Note on RMD Calculations and Growth Buckets
The IRS calculates your required minimum distribution on the balance of the account at the end of December 31st. If the IRS states that you need to withdraw $12,000 per year, it doesn’t matter if the markets are up or down 100% that year – you still need to take the full distribution.
When offering retirement planning, we often use a bucket strategy.
In this article, we’ll discuss the:
Income/Safety bucket
Growth bucket
Why? They offer advantages in a down or up market, helping you mitigate some of the risks your accounts have in retirement.
The income safety bucket often isn’t correlated with the market so:
It provides income
Protects against stock market volatility
The growth bucket is, in all essence, money in the stock market. Last year, the market was down 20% or more.
When both buckets work together, it helps safeguard against the market. Money comes from the income bucket and the growth bucket is allowed to grow long-term and mitigate retirement accounts being down.
Income buckets buy us time so that we don’t remove money when an account is down.
During a year like 2022, the growth bucket was allowed to recuperate while still having a steady income from the income bucket. If you have all your money in a growth bucket, it leaves you very little room to mitigate losses.
Note on RMDs and Multiple Accounts
For the sake of simplicity, let’s assume that you have 3 IRA accounts and the government states that you need to take a $12,000 RMD annually. Your distribution can come out of one account, a combination of accounts or all your accounts.
You may have $1 million in an IRA and decide to put 50% in an income bucket and 50% in the growth bucket. You can take all the distribution from the income bucket and let the growth bucket grow.
However, if your money is in a 401(k), there are stricter rules. Money in the 401(k) must come out first if multiple other non-401(k) accounts exist.
You can also put money from a 401(k) into an IRA with different strategies, which may be a better option for you.
Quarterly RMDs: Advantages and Disadvantages
Quarterly distributions are middle-of-the-road. You’re between the monthly and annual distributions, and the advantages and disadvantages are very similar to monthly.
For our clients, it’s always a monthly or annual distribution because many people don’t prefer the quarterly option.
Annual RMDs: Advantages and Disadvantages
Annual distributions are ideal for clients who want to keep their money in the market and let it grow as much as possible. Since the account balance may be higher, you’ll benefit from higher returns.
You can also have a down year where you’ve lost money and now need to take it out of the account when you’re in the negative for the year.
During up years, you benefit from greater returns
During down years, you lose some money
What’s best for you? Consider your personal preference and needs. If you need a monthly paycheck, then the monthly RMD is best. However, if you plan to reinvest your RMDs because you don’t need the extra cash flow, it may be better to go with the annual RMDs.
A retirement-focused financial plan is what we recommend to our clients. The rules of RMDs are general, but your case is always going to be unique. Analyzing financial plans in retirement allows us to optimize income and RMD planning.
We can walk you through how this looks, even if you’re not currently a client of ours. You can schedule a 15-minute complimentary call with us that will allow you to discuss your options with us to have a more personal discussion about your RMDs and retirement plan.
We do love it when someone refers a family member or friend to us. Sometimes the question is, “How can we introduce them to you?” Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.
Here are this week’s items:
Portfolio Update: Murs and I have recorded our portfolio update for June 20, 2023
This Week’s Podcast – Mid-Year Tax Planning – Why So Important in Retirement?
It’s important to look at the previous year’s tax situation because some things, like Roth conversions and qualified charitable distributions, need to be done before the end of the year in order to be reported on your tax returns.
Listen in to learn the importance of coming up with a good tax withholding strategy to avoid tax liabilities and bills during tax season. You will also learn about the tax benefits of donor-advised funds and qualified charitable distributions.
This Week’s Blog – Mid-Year Tax Planning – Why So Important?
Why are we talking about tax planning in the middle of the year? Mid-year tax planning allows you to get everything in order before the end of the year to lower your tax obligation as much as possible.
In June of 2023, we’re doing a lot of work to get ready for our tax planning and strategy meetings we’ll be having later this year. A lot of prep work goes into these meetings because it’s one of the most intense that we’ll have all year.
Why are we talking about tax planning in the middle of the year? Mid-year tax planning allows you to get everything in order before the end of the year to lower your tax obligation as much as possible.
Note: We are not giving specific advice. We’re talking in general terms and advise you to discuss your own tax planning with a professional who can recommend the best method to reduce your tax burden.
In June of 2023, we’re doing a lot of work to get ready for our tax planning and strategy meetings we’ll be having later this year. A lot of prep work goes into these meetings because it’s one of the most intense that we’ll have all year.
Why Do We Do Tax Planning and Tax Strategy Before the Beginning of the Year?
First, we want to review your tax situation from last year so we can understand potential moves we can make before the end of this year.
For example, Roth conversions or qualified charitable distributions (QCDs) need to be made before the end of the year to be reported on your tax return. Changes to your contributions or account conversions must be completed before December 31st of the year to be claimed on your taxes.
Mid-year tax planning helps us get everything in order to have a discussion with our clients on which strategies we can employ to lower your tax burden.
How Financial Planning Ties into Tax Planning
Financial, tax, and retirement planning are all linked together, or they should be if they’re done professionally. We have clients who first retire and live on cash in the bank, and then they start taking money from an IRA or a required minimum distribution.
In our process, at the beginning of the year, we have a financial planning meeting to update where their income is coming in this year, and we review what happened in 2022 (or the year prior).
From an income perspective, we want to understand where your income came from last year. We want to understand any unique changes that may have transpired this year and your income last year.
During the year, you may have income coming in from multiple sources, and it’s crucial that you have a good tax withholding strategy in place.
Proper tax withholding will allow you to avoid any unexpected tax surprises the following year. Having conversations throughout the year allows us to position our clients to pay less taxes by making smart financial decisions.
For example, if you want to sell a highly appreciated stock, we may recommend holding off until the beginning of the coming year because there are tax advantages.
We perform a full software analysis of our clients’ past year taxes to look for:
Filing status
Social Security number accuracy
Sources of income (interest, dividends, etc)
Withholdings
We look through all these figures with our clients to help you better understand the tax obligations of each form of income. If you want to adjust your withholdings or make income changes, we’ll walk you through this process.
For example, you may not want a refund at the end of the year and want to withhold just enough taxes to be tax-neutral. You won’t pay or receive anything at the end of the year from the IRS.
With a mid-year tax plan, we have a better understanding of the steps that must be taken to reach your goals in the coming year.
Things to Do Before December 31st
Retirees must do a few things before the end of the year by law. Here’s what you need to know:
Donor-advised Funds
Sometimes we learn from a tax return or through a conversation with our clients that they give $10,000 to charity per year. Can you itemize? Sure, but the standard deduction is so high that it often doesn’t make sense to do this.
What’s the Standard Deduction
For your reference, the standard deduction in 2023 is:
Single: $13,850
Married filing jointly: $27,700 (65+ goes up by $1,500 per spouse)
Itemization won’t make sense if you have less than the standard deduction amount in contributions.
If you do a donor-advised fund, you can stack charitable contributions and use the multi-year contributions as a deduction this year.
Let’s assume that you put $40,000 into a donor-advised fund. You can still make $10,000 contributions to your favorite charity, but you can then take a $40,000 deduction this year to negate your tax burden. Itemizing is the best course of action if you have more deductions than the current standard deduction amount.
We may recommend this strategy if you expect a very high tax burden and want to lower your tax obligation.
Opening a Donor-advised Fund
We use Charles Schwab for our funds, but you can use a custodian of your choosing. A donor-advised fund looks just like any other account held at Charles Schwab, except for a few differences. Checks are written directly to a Schwab charitable account and funds are held directly in this charitable account. You can assign contributions to charities of your choice.
Funds remain in the account and can be withdrawn and moved to the charities in the future. Once you put money into the fund, you cannot reclaim it in the future. You can decide annually on who you want to distribute contributions to.
However, it is very important that Charles Schwab has information on the charity that you want to disperse the money to and that everything is in order for the distribution to be made problem-free.
Qualified Charitable Distribution
Qualified charitable distributions (QCDs) are another tactic that you can use if you’re over the age of 70-and-a-half. Age requirements and the time of your distribution are crucial and one of the reasons that people often work with a financial planner.
We can make sure that you’re making the QCD properly and get all the tax benefits that go along with it.
Note. If you have a required minimum distribution (RMD), you can set up the QCD to be taken directly from this. A key benefit is that if the RMD never hits your bank account, you don’t have to pay taxes on it.
Making Out Your QCD Check
In terms of Charles Schwab, we want to make sure that the QCD check is made out directly to the charity and not the account owner. If the check is written to the tax owner, it is considered taxable income.
We need a few things when writing out the QCD check:
Name of charity
Charity’s tax ID
Charity address
QCD amount
One important thing to note is that there’s an option to send the check directly to the charity or to the account owner, who can then hand-deliver the check to the charity.
The most important thing is to have the check written to the charity itself with the tax ID.
What You Need to Gather for a Tax Planning Strategy Meeting
Whether you work with us or someone else on a tax planning strategy meeting, you’ll need a few documents to get started:
Last year’s tax returns
Income for the coming year
Changes to income in this year
Change to cost of living on Social Security
We really need to know your sources of income and if any changes to this income have occurred in the last year. Cost of living adjustments are a big one and will impact your taxes, but all of this is information necessary for a tax planning strategy meeting.
IRMAA is another thing that we want to consider, and we have a great guide on the topic, which you can read here: IRMAA Medicare Surcharges.
Medicare looks back two years to determine your surcharges, which is something we can plan for with enough time and a strategy in place. We want to manage your Medicare surcharges so that you don’t need to pay more than necessary for your Medicare.
Tax strategy can help you better prepare for your taxes and make strategic moves that will save you a lot of money in the future.
We have a team of people working with us to handle all these moving parts and walk our clients through the process.
