Finance - HL 222 (1)

Smart IRA withdrawal strategies

Yes, the IRS requires distributions, but you get to choose what to do with the money.

• Fidelity Viewpoints
• – 09/24/2014

Every year, if you’re age 70½ or older, you generally need to withdraw a certain amount of money from your traditional IRA, 401(k) plan, or other workplace savings plan. These minimum required distributions—known as MRDs or RMDs—are usually taxed as ordinary income. (Part of these distributions may be nontaxable if you've made after-tax contributions to these accounts.)
It’s important to determine how they fit into your overall retirement income plan, especially if you need the cash flow to cover expenses. While the IRS requires you to take MRDs, you have some flexibility on timing and what to do with the money. For instance, if you don’t need it for living expenses, you may want to give it to your heirs or a charity.
“Building a sound retirement income plan—one that can match your income sources with your expenses—is a critical component in achieving overall financial success during retirement,” says Ken Hevert, Fidelity vice president of retirement products. “Making the best use of your savings and distributions can help avoid costly mistakes. And if you don't absolutely need the money, you can make some decisions about the best way to use it."

Here are four key questions that can help you come up with an MRD strategy.

1. Do you need the money to cover living expenses?

“If you’re planning to spend your MRDs, one big consideration is managing your cash flow,” explains Hevert. “You may want to consider arranging to have payments sent directly to a cash management account that provides flexible access to the money with features such as checkwriting, ATM use, and online bill payment.”
Arranging to have the money automatically distributed to a cash management or taxable brokerage account also helps to ensure that your MRD requirement will be met by the deadline of December 31 each year, avoiding an IRS penalty on missed or underfunded distributions.
When planning your budget, bear in mind that you’ll generally owe income tax on any MRDs and other distributions from traditional retirement accounts. You can have taxes automatically withheld from your MRDs. If you choose not to do this, make sure you set money aside for tax time, and be careful—sometimes underwithholding can result in a tax penalty.
There are a few different withdrawal methods that you may want to consider to help you satisfy your MRD requirement:
Annual recalculation: Generally requires annual distributions from your account based on your life expectancy. It is recalculated each year.
Purchasing an income annuity: The purchase of an annuity can help turn your IRA assets into a stream of income payments that’s guaranteed¹ for life, and take care of MRDs at the same time.² (There are a number of limitations on the types of annuities than can be used to satisfy MRDs, so be sure to check with a tax professional.) Additionally, only the amount used to purchase the annuity may satisfy your MRD requirement. If you have other IRA accounts, you will still need to meet required distributions for them.
Annuities have advantages—most eliminate the need to worry about outliving your money, for one—but also drawbacks, such as the loss of access to your principal. Weigh the purchase of an annuity carefully, and do so in the context of a broader retirement plan. There are two payment options:

• Fixed payment option: Lifetime payments remain level (although you may choose a cost-of-living adjustment to increase payments and help keep pace with, or even hedge against, inflation), and access to additional principal withdrawals is limited.
• Variable payment option: Lifetime payments vary over time, based on the performance of the underlying investments you choose. In some cases, additional withdrawals after purchase may be allowed.³

2. Do you plan to reinvest the money?

If so, you may want to consider having any MRDs routed to one of your nonretirement accounts, where you can invest the money according to your goals, time horizon, risk tolerance, and financial circumstances.
If you invest your MRD in a taxable account, you may want to consider owning tax-efficient securities to help potentially reduce your tax liability, such as:

• Tax-free municipal bonds and municipal bond funds. These pay income that is free from federal income tax and, in some cases, from state and local taxes (note that income from some municipal bonds and mutual funds is subject to the federal alternative minimum tax).
• Stocks you intend to hold longer than a year that may pay qualified dividends. Sales of appreciated stocks held more than a year are taxed at lower long-term capital gains rates. Just be sure any dividends the stock pays are qualified. Qualified dividends are taxed at the same low rates as long-term capital gains, but nonqualified ordinary dividends, such as those paid by many real estate investment trusts (REITs), are taxed at ordinary income rates.
• Equity exchange-traded funds (ETFs). The unique structure of many ETFs investing in equities may help investors by allowing them to delay realizing taxable capital gains.
• Tax-managed and other tax-efficient equity mutual funds, such as index funds, trade infrequently and may use other techniques that seek to reduce a shareholder's tax liability.
• Low-cost, tax-deferred variable annuities. For investors with a time horizon of 10 or more years, this annuity allows potential earnings to grow tax deferred until withdrawn.

Meanwhile, you may want to consider investing the remaining assets in your IRA or other retirement plan in investments that are not, or are less, tax efficient, such as taxable bond funds, REITs, or short-term stock holdings.
Remember, be sure to allocate the money according to investing fundamentals. "Know what the purpose of the money is, how long until you'll need it, and how much risk you're willing to take—and invest accordingly," says Hevert.

3. Do you plan to pass assets on to your heirs?

If so, you may want to consider converting IRA assets to a Roth IRA, where you’ll no longer have to worry about MRDs and distributions are not taxable.⁴ Before deciding, compare the tax rate on converted IRA assets (your current rate) to the tax rate your heirs would pay on inherited assets. If your heirs will be in a much lower tax bracket than your own, then it may not make sense to convert.
Because a Roth IRA has no minimum required distributions during the lifetime of the original owner, you can leave the assets in place for as long as you live, with the potential to generate tax-free growth. Your heirs will have to withdraw a minimum required distribution each year after they inherit the account, but they generally won't be taxed on those distributions, which potentially increases the value of your bequest.
If you are age 70½ or older, you will have to take an MRD first before you convert the remaining assets in your IRA to a Roth IRA (although you can use the MRD to help pay the tax cost of converting the remaining assets). Note: While Roth IRAs are generally not subject to income tax, they are still subject to estate tax, so it is important to plan accordingly.
If you do convert an IRA, you'll have to compute the income tax on the portion of the account assets converted (note that this tax cost may be reduced in proportion to the extent you have made any nondeductible contributions to any IRA, even if it’s not the one being converted).

4. Do you want to make charitable donations now?

If so, a strategy involving a Roth IRA conversion and simultaneous charitable contributions may advance your philanthropic goals while eliminating the need for MRDs in the future.
The strategy involves performing a Roth IRA conversion, then making a charitable contribution in the same amount as the conversion. In general, the goal is for your donation to help reduce your taxable income by the same amount that the conversion increases it, leaving you with little or no tax impact. You could also make the charitable contribution to a charity that has a donor-advised fund program and recommend grants to other charities from your donor-advised fund over time. Note: There are IRS limits to deductible charitable donations. The amount you can deduct for charitable contributions cannot be more than 50% of your adjusted gross income. Your deduction may be further limited to 30% or 20% of your adjusted gross income, depending on the type of property you give and the type of organization you give it to. A higher limit applies to certain qualified conservation contributions.
For example, say you plan to convert a traditional IRA to a Roth IRA, and $100,000 of the assets in the account will be taxed. Making a $100,000 deductible charitable donation from a taxable account would generally offset the converted assets, leaving you with little or no additional tax liability.
The upshot? Your account would be converted to a Roth IRA—eliminating MRDs during your lifetime and providing tax-free potential growth⁵—at little or no cost, and you'd advance your philanthropic objectives.
"This move is driven by the desire to convert to a Roth IRA," cautions Hevert. "If you don't have a need for a conversion, you may be better off not converting and simply making a charitable donation."
Generally, anyone who is over age 75 and has large charitable intentions may not want to convert to a Roth IRA. Typically, the most tax-efficient asset to leave to charity at death is a traditional IRA, because the charity does not pay income tax, and the charitable bequest is deductible against an investor's taxable estate. Tax planning can be complex, so consult a tax adviser before taking any action. Read more in Viewpoints: “Tax-savvy Roth IRA conversions.”

Have a plan

Whichever scenario applies to you, MRDs are likely to play an important role in your finances in retirement. Building a thoughtful retirement income plan can help you use MRDs in the most effective way, and help you reach your important financial goals. At the very least, it's important to spend some time understanding MRDs and your options with a tax professional, to help avoid a costly mistake, and to ensure you are meeting the IRS requirements.

Learn more

• For Fidelity retirement accounts, consider setting up automatic MRDs (login required.) 
• View your MRD Calculation Estimate and the year-to-date distributions for your IRAs and small-business retirement accounts in the Retirement Distribution Center (login required.) 
• Frequently asked questions about MRDs.

Helpful miscellaneous articles regarding our retirement plan and planning.  Like you, I review my retirement nestegg and plan from time to time.  Recently, I went though some continued education for some credentials I maintain and it occurred to me that we all could use a review about these issues.  So with your help, we will share and post articles and info that may be helpful and of interest to many of you in this section.

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(As with any of these informative articles, anyone who needs someone to talk to about

this very subject contact me and I can direct you to a knowledgeable advisor).

 


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