Do you have an IRA or 401(k)? Then you will have to take a RMD.
Episode 1: Required Minimum Distributions (RMDs) in 2020
Published on: Dec 18, 2019
HERE ARE JUST A HANDFUL OF THE THINGS THAT WE'LL DISCUSS:
- Why do RMDs exist?
- How are the rules different for those who inherited a tax deferred account?
- How can I calculate how much my RMDs are going to be?
- What types of accounts have RMDs?
- What is the penalty for failing to properly withdrawal the RMD?
- How did the new SECURE Act of 2019 impact RMDs?
[accordion] [accordion-item title="Transcript (Click to see full transcript)"] Ben Christy: And there's a book out there, Pete, I'm a big fan of, read it several years ago by Simon Sinek called Start with Why. That's what I want to do, I want to start with the why this morning and let's talk about why RMDs even exist in the first place. Pete Benson: Well, the reason has to do with tax benefits of certain retirement accounts. If you own an IRA or a 401k or other pre-retirement accounts, you will be impacted by this RMD stands for Required Minimum Distribution. With a traditional IRA, or let's say it's a 401k or a 403b similar account, you get an upfront tax deduction for the amount that you contribute towards the retirement. So let's say you put in 5,000 or 7,000 or whatever, you get a tax break now. You also get tax deferred treatment of any income and gains over the years. So it could be 10 years, 20, 30, 40 or so. So that asset continues to grow, that means no taxes due until you start making withdrawals. So if Required Minimum Distributions didn't exist, you could literally let your savings sit untaxed for your entire life and then pass those savings onto your heirs who could then pass it, onto their heirs, and so on and so on. Ben Christy: I like that. Pete Benson: This way the government though doesn't get any sugar. Ben Christy: That's right. Pete Benson: They gave you that break, but it's like give me something back. They're going to get it back through Required Minimum Distributions for a lot of people over a 20 plus period of time. And even though those tax breaks sound good to us, the lawmakers didn't like the idea of allowing our investments to grow just untaxed for generations. So forcing those withdrawals then causes retirement savers to eventually pay taxes on those savings and the government gets their sugar back. And so that's the big point here, is taxes to pay uncle Sam back. Ben Christy: Because we know they're going to get theirs. Pete Benson: It's coming. Ben Christy: So talking about uncle Sam again, the US government, Congress, Senate specifically passed the SECURE Act 2019 on December 19th, 2019 and then on December 20th president Trump signed that, put in place. Of course SECURE is, they're very genius here with their acronyms stands for Setting Every Community Up for Retirement and that's just what it is. And so the goal here is the new law was really intended to expand opportunities for the individuals to increase their retirement savings very simple, straight forward approach to it. Now the bill itself is not so simple and straight forward. There's lots of nuances that we're still trying to get our head around because there's so many things here that were included in this bill. And one of the items though includes a new age for RMDs. And so Pete, can you start at the beginning and give us a quick overview of what our RMDs and then how the SECURE Act is changing this approach to RMDs. Pete Benson: It's a required withdrawal from your retirement account at a certain age and there are certain percentages based on your age that you have to pull out and then as you do that become taxable at that point. And the requirement keeps going up with age. So prior to the new act, the magic age was 70 and a half that the IRS required you to now withdraw a certain amount of money depending on how big your retirement account is from your IRA 401k or other tax deferred account. And if you didn't get this, there is a very steep penalty so you don't want that to happen. So with the new bill, they changed the age a little bit later now because people are living longer from 70 and a half to 72. So a year and a half later you can wait if you don't need to take that, you have to take it at 72 but because of how long people are now living, you essentially are going to take money out of it for a long period of time if you live to be 90 or 95 years old. Pete Benson: The stiff penalty that you are assessed, if you don't take that out is 50% and it's often misunderstood or ignored this penalty and just how the RMDs work. Many people are caught unawares when it's really time. Ben Christy: Yeah, well at least if nothing else it's a big win because now we don't have to try to figure out when our 70 and a half birthday is, it's much easier to keep up with 72 so that's a bit of a win. And so look at it this way too, were you born in the second half of 1949 between July 1st through December 31st if so, the new law applies to you. If you were born before that, don't worry about the new law, you're out of that. That's where you pick it up. And I know one the reasons, Pete you mentioned that this new law is even in place is because people are living longer. Life expectancy continues to be drawn out. And I think it's extremely important that we understand the rules here because if you miss the first year of that RMD and you end up having to take two RMDs in one year, in your first year especially, it could put you in a higher tax bracket and that could be really be detrimental to your savings account. Pete Benson: There's a snowball effect in how that works and putting you into a higher bracket and then what you pay for, how much of your social security is taxed, what you pay for Medicare. There's a lot of different things that are impacted and again, that Medicare high income surcharge, if you will, it's like a wealth tax. If your adjusted gross income plus tax exempt interest income rises above $85,000 if you're single and if you're married 170,000 that extra income could also cause a larger portion of that social security benefit that you're hopefully enjoying when you're that age to be subject to taxes. So again, not only are they taxing your retirement, then there's a domino effect that happens as well. Ben Christy: And we say this a lot on even the radio show, Beacon Retirement Strategies. Two things can really eat retirement up, right? One is taxes, the other's expenses. Pete Benson: Right, bills and taxes. Ben Christy: So you’ve got to get RMDs right, because you can be penalized on both sides? There's stiff penalty, 50% fee here, and then the increase in taxes. Ben Christy: So I think another big question that a lot of people have, Pete, that we want to try and address is, how do you begin to determine how much RMDs are going to be? And I know for a lot of clients here at Beacon, they're like, Oh, I just call Pete up and Pete helps me work through because it's a little bit complex. Pete Benson: It is a fact that we do help hundreds and hundreds of clients every single year and that's what we're here for. But a lot of people don't have somebody to call on. So I think it's important to remember that the goal or the point of the RMDs from the IRS is to ensure that you withdraw all of your retirement savings over the course of your lifetime. So calculating your RMDs isn't overly complicated if you know what you're looking for, it's rather simple. Step one, determine your retirement account balance as shown on your statement December 31st of the prior year and that's each and every one. Step two, is to divide this amount by the distribution factor, which is a number you'll find on the appropriate IRS life expectancy table. And of course you can find this chart by doing a quick online search for IRS uniform lifetime table or Required Minimum Distribution worksheet. Step three, last step is to divide your retirement account balance by the distribution factor from the IRS table. Pete Benson: The result is how much you will need to withdraw for the given year that you'll need to do that each and every year and people say, well, how much do I withdraw for taxes? It depends on where that's going to now put you in the bracket. Then you may withhold that and have that automatically sent or you can pay your taxes later. Ben Christy: Yeah, a lot of math goes into this. Pete Benson: A lot of math. Ben Christy: I just want to walk down this list real quick for you because these are the accounts that require RMD and this is another important thing that you need to be aware of because Roth is the thing that can really get a little tricky here in some circumstances. But you need to know the accounts that are subject to Required Minimum Distributions. They are as follows, traditional IRAs, rollover IRAs, your inherited IRAs, your SEP, IRAs, your simple IRAs, your 401k, your 403b, your 457bs. There are no required minimum distributions for your Roth IRA unless *it's inherited and that's something we're going to talk about here in a moment. Though RMDs are required for that other Roth, your Roth 401k. So again, it's understanding the rules here so that you can learn how to play within it and you can win. And Pete I think we would be amiss if we didn't talk about the rules for RMDs, if you inherit, like we said, if you inherit that IRA and that stretch IRA, I know the rules particularly with the SECURE Act, they've changed. Ben Christy: And so can you talk a little bit about, and this is the operative word, what a stretch IRA was because it's really no longer a thing, is it? Pete Benson: It was a really great estate planning strategy that applied to inherited IRAs. So that's one that would come say from a non-spouse beneficiary. So not my wife, but my parents that may have left one to me. By using the stretch strategy, an individual IRA account could be passed from one generation to another, taking advantage of tax deferred and or tax free growth of the assets within it. However, the SECURE Act requires that most non spouse IRA and retirement plan beneficiaries to now drain that account after they inherited it within 10 years of the owner's death. This is a big anti-tax payer change for financially comfortable folks who don't need their IRA balances for their own retirement years but wanted to use those balances to set up a long term tax deferred deal for their heirs before the SECURE Act, the required minimum distribution rules allowed you as a non-spouse beneficiary to gradually drain that substantial IRA that you inherited and stretch it out over a long period of time. Maybe 2030 40 years, not anymore. Ben Christy: Right. Well said and again lots of rules here that we need to understand. Go back and re listen to this podcast again or go online, look up new SECURE Act and RMDs and you'll be able to see lots of articles out there that are covering this stuff because there's so much involved. Pete, another issue here because I think we can encourage people to know your RMD, know your amount. But you touched on this briefly is there's unwanted tax consequences here that some cases you just, because you get that bump, you have to learn how to deal with that and I think that would be good as we close out this podcast. To talk about what are some of those, strategies that we can apply here knowing that we're going into this season of life with RMDs. Pete Benson: I'd say the number one best strategy is to have a plan way ahead of time, period. I mean most people don't even think about this until well, that's when I have to pay it. So I'll think about it and talk to somebody then. So they call us up. I would say years ahead, you need to be planning ahead because there's a lot of things that possibly could be done to help you with this. Become more tax efficient. You see, tax deferred is not tax free the key word is yet it's not taxed yet, but it will be at some point, for instance- Ben Christy: What age would that be Pete? I mean 50s, 60s what would be a good time to go, this is my cutoff, I really need to be. Pete Benson: In your 50s anytime is not a bad time, but especially in your late 50s thinking about, okay, I'm becoming 60, that age between 60 and 70 there's a decade there, that 10 year period a lot can be done to really help you. Ben Christy: Yeah, that's good. Pete Benson: So if you've got a plan going into retirement that can use your tax deferred accounts in the early years of retirement, hopefully providing you with enough income so that you do not need social security in delayed 70 then you get to max out your benefits from social security. So that's just one of many strategies that we employ all the time. And then ways to reinvest your RMD money, so sometimes people don't need it, you can reinvest. And then there's this thing called Qualified Charitable Contributions, QCDs, they call them. And that is a way to let some, or part or all of your required minimum distribution now go directly to some nonprofit organization or church. It doesn't touch your hands and it goes to them tax free and now you don't have to pay the taxes on it, but you get to be very charitable and that can be a very good thing. And so there's just so many different things. And then there's ways to maybe shift some of that IRA money to a Roth IRA over a period of time. Pete Benson: And you actually can still stay in a fairly low tax bracket oftentimes if you just take little pieces of time, maybe it's 10,000, 15, $20,000 a year over 10 years now you've shifted perhaps to the $300,000 that was going to be taxable someday, maybe at a higher rate now you get to do it at a lower rate. So there's lots of different things that we can, it's always smart to have a plan ahead. Ben Christy: And then you say this a lot too. And I like this advice to a lot of people that are walking through and planning for that RMD. Always overestimate, overestimate your RMD because you never want to underestimate that and hit that 50% penalty. Pete Benson: That's right. It doesn't hurt to take a few dollars over, that's a precaution that gives you some peace of mind. Ben Christy: Because we talked about there's a lot of stiff fees when it comes to financial investing, but that 50% penalty on RMDs, that is a serious one. Pete Benson: I don't know. I mean it seems like only the IRS could get away with that one. Ben Christy: Only the IRS. Yeah. Well Pete, thank you for your time today. Appreciate your sharing with us and walking through RMDs. Again, if you have any other questions, feel free, jump online, look at some other podcasts we have available at beaconcm.com/podcast. To everyone listening, thank you for joining Pete and I for another episode of Beacon Retirement Strategies and always remember that peace of mind in retirement requires a plan. Investment advisory services offered through Beacon Capital Management, LLC and SCC registered investment advisor. Beacon Capital Management, LLC is neither an affiliate or subsidiary of TD Ameritrade Institutional, Fidelity Investments, Beacon Accounting and Tax Service or Night Legal. [/accordion-item] [/accordion]