Planning for Required Minimum Distributions

Required minimum distributions (RMDs) from retirement plan accounts have been the law of the land for many years.  In recent years the rules have been simplified and made more taxpayer-friendly.  For 2014, those subject to RMD requirements need to pay special attention.  First, some background: 

 

If you turn age 70 on or before June 30 of this year you must take a withdrawal from your retirement plans and IRAs by April 1, 2015.  If you are already 70 ½ or older as of January 1, 2014 or you are the owner of an inherited IRA, you must do so by December 31, 2014.  The withdrawal is 100% taxable, and the tax penalty for not doing so is 50% of what you were supposed to take. 

 

The RMD for each new year is calculated on your account balance as of December 31 of the preceding year, based on a special life expectancy table.  Whether one is married or not, it automatically assumes a life expectancy of an account owner with a spouse 10 years younger. This results in lower RMDs than if it was based on just your own life expectancy. 

 

Taking a look at the Uniform Life Table, someone turning 70 on say, June 30 this year, would be required to take 1/27.4 of the December 31 account value by April 1, 2015. For example, the RMD of a $1,000,000 account balance would be $36,496.  (As a practical matter, to avoid the need to take two RMDs in 2015, most account owners typically take their distributions by December 31 of this calendar year.)  Someone turning 70 July 1 or beyond would use a divisor of 26.5, and must start by April 1 of 2016. An 80-year old would need to take $53,475 ($1,000,000÷18.7).

Uniform Life Table*

From IRS Publication 590

Age

Divisor

70

27.4

71

26.5

72

25.6

73

24.7

74

23.8

75

22.9

80

18.7

85

14.8

90

11.4

95

8.6

100

6.3

* For use by unmarried owners, married owners whose spouses are not more than 10 years younger, and married owners whose spouses are not the sole beneficiaries of their IRAs

Inherited IRAs

 

 

Yes, even children can be subject to RMDs!  If you or your child are a non-spouse beneficiary of an inherited IRA, you do not get the same favorable divisors.  Instead, you must use the Single Life Expectancy Table which is based on just your life. In the examples below, at age 70 your divisor would be 17, and your RMD would be $58,823.  At age 80, the numbers would be 10.2 and $98,039.  Furthermore, you are subject to RMDs by December 31 following the year of the death or the owner.  A 40-year old, for example would have a divisor of 43.6 and would have an RMD of $22,936.

 Single Life Expectancy Table*

From IRS Publication 590

Age

Divisor

10

72.8

20

63.0

30

58.2

40

43.6

50

34.2

60

25.2

70

17.0

80

10.2

90

5.5

100

2.9

*For use by beneficiaries to determine starting year divisor.  Thereafter the divisor decrease by one year each year.

What’s New For 2014?

 

By now, those subject to RMDs have received notices from their retirement plan custodians of the amount they must withdraw and pay taxes upon by December 31, 2014.  In the years immediately after 2008 and 2011, many recipients saw declining or stable RMD amounts.  To meet cash flow needs, they actually withdrew more from their IRAs than was required.

 

However, since stock-based and balanced accounts did so well last year, the RMD for 2014 can easily translate into a double-digit increase over the 2013 RMD.  This means more cash flow and more income taxes—and a boost to the Federal coffers.  We’ve seen with some of our clients the temptation to think of it as “free” or “found” money that can pay for bigger and better trips, toys, and gifts to the kids.

 

Before you think that way, remember how PERS got into such a mess.  In the late 1990s when returns were stellar, instead of crediting each beneficiary’s account with the mandatory 8% rate, the trustees made double digit credits.  Then the lean times hit, and PERS was no longer actuarially sound.  So, before you go out and spend what I call this “mandated windfall,” make sure your retirement assets in and out of retirement plans are actuarially solid to a ripe old age.

 

Also, last year the 3.8% Medicare Surtax came into effect.  This kicks in on net investment income when one’s Modified Adjusted Gross Income exceeds $250,000 for couples and $200,000 for singles.  The details of how this works are beyond the scope of this article; however, my point is that this additional taxable income from your RMD could put you over the threshold, making your net investment income subject to the 3.8% surtax.   As you meet with your tax professional this spring, be sure to ask about this. 

 

Planning Suggestions

 

Charitable Deductions.  One of the possible solutions might be to increase your charitable deductions.  Run this by your tax professional and financial advisor to see if you can afford to do so, and how it might pencil out.  

 

Tax Diversification.  If you aren’t yet subject to RMDs, this might be a good time to consider your tax diversification strategies.  If you are like most medical professionals, you probably have a majority of your nest egg in qualified retirement plans.  Perhaps, instead of maxing out every year, you might consider paying more in income taxes now by investing in non-qualified accounts outside of retirement plans, such as an investment account under a joint account, individual account, or in your living trust. 

 

Roth IRAs.  If your income is below $127,000 (single) or $188,000 (joint), you may qualify to contribute to a Roth IRA account.  Yes, you won’t get the tax deduction, but you are diversifying your tax bill over different time periods.  Furthermore, your Roth IRA won’t be subject to RMDs.  Likewise, if you have a low tax year, consider converting some of your IRA account to a Roth. 

 

Tax and Retirement Planning.  As I mentioned, meet with your tax professional early in this calendar year. It’s too late to deploy strategies on New Year’s Eve.   Your financial advisor can help you determine the adequacy of your capital.  Maybe you can afford to spend this windfall, but you will enjoy doing so more if you know that it won’t hurt you later. That's where The Confident Retirement Journey or a good financial advisor can help you.

 

(Ron Kelemen is an independent  CERTIFIED FINANCIAL PLANNER™ with 33 years of experience, and the author of The Confident Retirement Journey—Your Personal and Financial Roadmap.  He offers fee-only investment management and wealth management advice through The H Group, Inc., one of the largest independent registered investment advisory firms in the Northwest.  You can follow his regular commentary at his blog post, located at the “Our Blog” tab of his website:  www.TheHGroup-Salem.com  and at www.ConfidentRetirementJourney.com | Water Place Building | 500 Liberty Street SE, #310 | Salem, OR  97301 | 800-285-6240.)

  

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