Strategy When RMD Exceeds Intended Withdrawal

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Electron
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Strategy When RMD Exceeds Intended Withdrawal

Post by Electron »

Many investors in this forum have put together a well designed portfolio for their tax sheltered retirement accounts and have plans for a withdrawal percentage in retirement.

What is the strategy when the Required Minimum Distribution exceeds the desired withdrawal?

The RMD exceeds 4% at age 73 and the percentage increases every year.

Age 73 RMD=4.05%
Age 80 RMD=5.35%
Age 90 RMD=8.77%
Age 95 RMD=11.63%
Age 100 RMD=15.87%
Age 115 RMD=52.63%

Thanks for any thoughts.
SpecialK22
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Post by SpecialK22 »

preempt the RMD with a Roth conversion?
Abudoggie
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Post by Abudoggie »

Ummm, convert to a Roth :roll: :wink:

Sorry not sure what you are asking. RMD rules exist to force you out of a tax-favored domain into a taxable one. FWIW, before they simplified the RMD rules, you could reach 100% required distribution in a given year if you did not opt to recalc life-expectancy. However, since the new tables incorporate life-expectancy recalc, you don't hit the 100% mark but do have to distribute an increasingly large proportion.

Essentially, your portfolio will be eroded to the tune of the tax hit on the RMD. You don't mention any other pertinent facts such as whether or not you also have assets in taxable accounts and if so, what proportion is the mix of tax-deferred to taxable. One strategy you should consider is to explore is your overall asset allocation is tax-effectively deployed among your accounts for which there are other threads on the topic as well as this resource:
http://www.bogleheads.org/wiki/Principl ... _Placement
Last edited by Abudoggie on Thu Jul 21, 2011 2:28 pm, edited 1 time in total.
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archbish99
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Post by archbish99 »

Note: Entirely hypothetical, as I'm not retired nor that old.

Yeah, personally, put as much in Roth as possible to avoid the issue. So long as 5-10% of my TIRA/T401k assets are less than the target withdrawal from my total assets, this shouldn't be a concern.

But if I were going to be hit with a forced withdrawal, I would say put it into 529s for grand-kids, into a trust fund for heirs (gift tax exclusion!), start a charitable trust of some kind, or just give it away.
letsgobobby
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Post by letsgobobby »

can IRA distributions be given to charity and both satisfy RMD and avoid taxation at the same time?
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TrustNoOne
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Post by TrustNoOne »

It may make sense to make earlier withdrawels to reduce the amount subject to RMD, but the part about Roth conversions always puzzles me a bit.

I don't really see what the advantage is in having a Roth account, as compared to say, investing in muni bonds or in stocks. If you invest in stocks gains are already tax deferred, and would be taxed later at the lower capital gains tax rate. If you are investing in bonds, then munis would be tax free as well. So I've never quite seen why a Roth is such a good deal. Perhaps someone could explain it.
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Higman
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Post by Higman »

Just pay your taxes on the RMD and reinvest as much of it to get to your 4% withdrawal figure.
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Christine_NM
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Post by Christine_NM »

It sounds like you are asking how to invest the excess RMD, not necessarily how to prevent it from happening.

Use whatever vehicle offers the most tax efficiency and keeps your AA intact. Such as, take an RMD from an IRA bond fund, spend some, pay taxes, and put the rest in a muni fund. Yield may be lower but it won't be taxable (at least today, don't know about the future).

If you had been spending from your taxable account earlier in retirement (60's) then it may be a bit depleted and large RMDs will build it up again.
18% cash 44% stock 38% bond. Retired, w/d rate 2.5%
SpecialK22
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Post by SpecialK22 »

TrustNoOne wrote: I don't really see what the advantage is in having a Roth account, as compared to say, investing in muni bonds or in stocks. If you invest in stocks gains are already tax deferred, and would be taxed later at the lower capital gains tax rate.
Dividends are not deferred.
Roth gains are tax-free on withdrawal, but a taxable account would pay capital gains tax on any gains. No tax is better than some tax.
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Electron
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Post by Electron »

Thanks all for the help.

My concern was maintaining one's long term investment portfolio after the RMD exceeds the desired withdrawal.

It appears that one should reinvest any excess withdrawal in a similar portfolio set up in a taxable account. As a result, one would need to manage a tax sheltered account along with a taxable account. In some cases, the taxable account could actually be increasing in size relative to the sheltered account over time.

One needs to realize that a portion of each RMD after a certain age may need to be reinvested. Spending the entire RMD may result in assets being depleted earlier than planned.

KW
Sidney
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Post by Sidney »

KAWill70 wrote: One needs to realize that a portion of each RMD after a certain age may need to be reinvested. Spending the entire RMD may result in assets being depleted earlier than planned.

KW
It helps to just think of an IRA (or similar deferred account) as a joint account where you and the IRS are joint owners. The RMD is just a distribution to you and them - it isn't "income." The total balance in the IRA was never yours to begin with.
I always wanted to be a procrastinator.
tms
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Post by tms »

Higman wrote:Just pay your taxes on the RMD and reinvest as much of it to get to your 4% withdrawal figure.
Exactly.

You can use Roth conversion if you have room in a particular tax bracket, but other than that, pay the tax and reinvest.
Alan S.
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Post by Alan S. »

The whole concept of a SWR contemplates a pot of assets that should only be depleted at the "safe rate". The pot of assets could be retirement accounts, taxable accounts, rental houses or whatever, but it more often associated with pre tax retirement accounts.

But it only matters WHAT the pot is composed of to the extent the liquidation of those assets is a taxable event such as an RMD. Once the RMD exceeds the SWR as it will just a couple years after RMDs begin, you just distribute in kind to a taxable account and accumulate the assets there to the extent the RMD exceeds the SWR. You would maintain your AA in total over all the accounts and possibly reposition certain holdings between taxable and tax deferred accounts based on tax law advantages.

If your retirement accounts are not a major portion of your assets, then it no longer matters how much you take out of the retirement accounts as long as your total expenditures are limited to the SWR. To the extent funds are taken from tax deferred accounts, there is a higher current tax cost than spending down taxable account assets.

Roth conversions might be incorporated, but only if they otherwise make sense in a given year. Taxes will be increased because the RMD must be taken out before any Roth conversion is done and both will be taxable. The conversion will reduce future RMDs, and will obviously accelerate the taxes in the short run, but depending on certain variables could reduce the tax hit over the remainder of your life expectancy.

A few decades ago, people only had taxable assets and monthly pensions, and relatively no tax deferred accounts. They didn't have formal SWRs then, but the concept was the same, ie you had to save a portion of the monthly income to avoid the risk of running short of funds even if your monthly income remained stable.
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Electron
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Post by Electron »

This discussion brings up an issue for anyone with many funds (such as Slice and Dice) in their tax sheltered portfolio.

Replicating the same portfolio in a taxable account might not be desirable, so perhaps one could use a simpler strategy in the taxable account.

KW
Easy Rhino
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Post by Easy Rhino »

KAWill70 wrote: As a result, one would need to manage a tax sheltered account along with a taxable account.
It seems most Bogleheads are prodigious enough savers that they already have at least one taxable and at least one tax-advantaged account. :o
staythecourse
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Post by staythecourse »

Read in one book the advice given is plan well ahead if you will need all that money when RMD comes around. If not they advice taking the year where your spouse and your income is the least and convert some to Roth.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
Alan S.
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Post by Alan S. »

letsgobobby wrote:can IRA distributions be given to charity and both satisfy RMD and avoid taxation at the same time?
YES.
The "QCD" (qualified charitable distribution) has been extended through the end of 2011. Under this provision, up to 100k can be directly transferred to a qualified charity from your IRA and it will include your RMD up to that amount or the amount of your RMD if lower. It eliminates taxes on the RMD. No itemized deduction is allowed for the contribution, but it is more tax efficient than a contribution from after tax funds.

Taxpayer must have reached age 70.5 to the day for a QCD.
Taxpayer must do the QCD prior to any other distribution for the year if they want it to cover the RMD because the first distribution is deemed to include the RMD.
If the IRA has basis, the entire QCD comes from the pre tax balance first.
DickBenson
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Post by DickBenson »

Abudoggie wrote:Essentially, your portfolio will be eroded to the tune of the tax hit on the RMD.
It is important in any decision making about RMDs (and Roth conversions} to understand that this is NOT really the case. The key is to understand that part of your IRA belongs to the government (ratio determined by your tax bracket upon withdrawals). Thus when you evaluate the size and the asset allocation of your portfolio, and your net worth, you need to subtract that portion of your IRA that "belongs to the government".

Larry Swedroe has pointed out that one can consider an IRA as consisting of 2 TAX FREE accounts, one belonging to you and the other belonging to the government. He also said that it was difficult for many financial advisors to grasp this concept, so I'm not going to try to explain this concept here. But this view can be used to see that when you convert an IRA to Roth, you essentially are replacing the government's tax free portion of your IRA with funds (investments) of your own that were originally in your taxable portfolio.

When you make a conversion, the net result is that you will have the same net worth, (can have same portfolio), but the size of the tax free portion of your portfolio (Roth) has increased by the amount of tax that you have paid.

A major caveat here is that the tax rate on all of the funds that you take from your IRA stays the same (i.e. that your share of the IRA stays the same). If this is not the case many other issues come up.

A quick example for 25% tax bracket:

IRA - $4,000
taxable funds - $1,000
Net worth - $4,000 ... (only $3,000 of IRA belongs to you)

After converting at 25% tax rate

Roth - $4,000 (that $1,000 now growing tax free)
Net worth - $4,000 (no change)

Thus, if all your RMD funds will be taxed at 25% (and no possibility of future RMD being taxed at a lower rate), and you do not need all of the RMD, one should consider "investing" the excess by using it to pay the tax on converting part of your remaining IRA to Roth. (Indeed you could consider converting even more of your IRA to Roth status, by using some of your taxable savings..... remember that this simply converts those taxable savings to tax free savings)

{Also, with this view, you can consider that when you take a RMD, it essentially move part of your share of the IRA to taxable status,,,, no loss of net worth)

Dick
Sidney
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Post by Sidney »

TrustNoOne wrote:It may make sense to make earlier withdrawels to reduce the amount subject to RMD, but the part about Roth conversions always puzzles me a bit.

I don't really see what the advantage is in having a Roth account, as compared to say, investing in muni bonds or in stocks. If you invest in stocks gains are already tax deferred, and would be taxed later at the lower capital gains tax rate. If you are investing in bonds, then munis would be tax free as well. So I've never quite seen why a Roth is such a good deal. Perhaps someone could explain it.
Invest in taxable bonds (higher yield) in a ROTH -- the higher interest is not taxed and normally would exceed the muni interest. Any dividends, gains, interest on any investments in the ROTH are not taxed.
I always wanted to be a procrastinator.
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Electron
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Post by Electron »

TrustNoOne wrote:I've never quite seen why a Roth is such a good deal. Perhaps someone could explain it.
A Roth IRA will have a significant advantage in the future if tax rates increase. A Roth IRA is also used in estate planning and can be a wonderful gift to a family member or friend.

As a result, Traditional IRA to Roth conversions can pay off in the future. In general, if the tax rate at the time of conversion is lower than future tax rates, the Roth will come out ahead.

However, one should note that there are two basic ways to do a Roth conversion.

In Method 1, you pay the conversion tax out of the T-IRA and wind up with a smaller balance in the Roth IRA. This is the easiest case to analyze. In fact, the two accounts are identical if the conversion tax rate is the same as future tax rates. If future tax rates rise, the Roth comes out ahead.

In Method 2, one converts the full T-IRA balance to a Roth by paying the conversion taxes out of existing taxable accounts.

Method 2 results in a very complicated analysis because one now needs to compare a T-IRA plus Taxable Side Account to a Roth IRA. The initial value of the Taxable Side Account is the amount needed to pay the conversion tax. Now one has to consider the investment return on the Taxable Side Account and any taxes due along the way. In addition, one has to analyze withdrawals from the Taxable Side Account in retirement along with IRA withdrawals, and there are different ways to handle the combined withdrawals.

KW
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