You just turned 72 and are now required to take Required Minimum Distributions (RMDs) from your retirement accounts. First, let’s define what exactly an RMD is. An RMD is a distribution the IRS requires all retirees to begin taking from their individual retirement accounts (IRAs) once they reach age 72. Your RMD amount is determined by dividing the account balance on December 31st of the previous year by the individual life expectancy factor based on your age. The factor information along with the calculation instructions can be found on the IRA Required Minimum Distribution Worksheet. Great, now what? You need to start taking distributions, but we’re experiencing a market downturn and you may be forced to sell assets at a loss. Luckily there are a few strategies you can implement to help stretch your retirement dollars a little further.
Case for Installments
One of the most frequent questions I hear from clients is, “When and how should I take my RMD?” You have a few installment options such as monthly, quarterly, semi-annually, or annually as a lump sum. Which is better? This all depends on your current financial situation. However, many advisors would agree monthly distributions are the most effective option as it reduces the risk that you’ll sell a large sum of assets at the wrong time. Think of it as dollar-cost averaging. Dollar-cost averaging (DCA) is the strategy of investing a fixed amount at regular intervals, regardless of the security price. Now think of dollar-cost averaging in reverse. It works off the same principle, but now you’re selling the assets at regular intervals throughout the year. Overall, this seems to be a better strategy than taking an annual lump sum at the beginning or the end of each year, which can expose you to the possibility of selling assets at the wrong time. If you don’t have a need for the income, this strategy can pair well with the next strategy, called an in-kind transfer.
An in-kind transfer can be a great plan of action if you don’t have a need for the income. Rather than selling assets at a loss, you can transfer the assets from your IRA to a non-qualified account to satisfy your RMD. Now you’re probably asking, “Will I still have to pay income tax?” The answer is yes, this is a taxable event. However, this strategy allows time for the market to recover before selling those assets later on down the road.
Convert IRA to Roth IRA
Another option is to convert all or a portion of your IRA to a Roth IRA. In this case, Roth accounts have no mandatory RMDs, and distributions are tax-free. There’s also the benefit of eliminating inheritance tax when the account is passed to your beneficiaries. An IRA to Roth conversion is a taxable event as you’re converting pre-tax money over to after-tax money. This strategy is aimed at maximizing tax efficiency, but at the same time, it can bump you up to the next bracket if you’re not careful. Lastly, you should be made aware Roth conversions do not satisfy RMDS, but can be a strategy to reduce them in the future. I highly recommend having a conversation with your CPA or tax advisor to ensure this option is suitable for your current financial situation.
Lastly, having cash on hand in your retirement accounts can help with the burden of taking RMDs in uncertain times. This cash can be held in CDs, money market funds, or short-term bond funds. These options are liquid and are generally stable during volatile markets. Having a cash bucket solves a problem that many lump sum takers run into if they wait until the end of the year for their distribution. In a rising market, taking the RMD as late as possible gives you an extra year of tax-deferred growth, but if your investments drop sharply in December, you’re boxed in.
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