Getting RMDs In Order
An RMD is the amount of money that you must withdraw from all of your qualified plans (except for Roths) once you turn age 70 ½. The following is a little history of RMDs.
The first federal pension law, Employee Retirement Income Security Act (ERISA), was passed in 1974. Prior to this law, companies could stiff their pensioners by moving across state lines ala Bonnie and Clyde, who would rob a bank in one state and avoid arrest by moving to another state because there was no federal bank robbery law (they fixed that in 1938). ERISA created the Individual Retirement Account (IRA) into which you could deposit 15% of your income up to $1,500 annually.
Congress continued to make changes and adjustments to the pension laws over the years. One of the provisions they set up was to let people “rollover” their pension plans, 401(k)s and other retirement plans into their IRAs. This resulted in the government losing huge revenues because people rolled over billions into their IRAs and were not required to take withdrawals. The government received their share only when people died. Congress realized it had shot itself in the foot. Fortunately, they did not discontinue IRA rollovers; instead, they came up with a complex RMD program.
RMDs began in 1987. Although they were complex and ugly, they were better than having a ban on rollovers into IRAs. Back in the ’80s, there were "recalculated and non-recalculated methods for computing life expectancy, which determines RMDs." Not only were these calculations complex, but an IRA owner could run out of money during their lifetime. Further, beneficiaries often had to cash out the IRA and pay the tax in one year.
Over the years, these problems have been somewhat ameliorated. Today, RMDs are fairly straightforward and must be provided to account holders by the IRA custodian annually. This information is also provided to the IRS, so if you do not take the proper RMD, you will be subject to the 50 percent penalty on the required amount you did not withdraw.
Also, the new laws are much more generous in allowing beneficiaries to stretch inherited IRAs over their lifetimes and those of their children. However, all of this requires proper setup and planning.
Now, I will discuss when and how to make the best decisions on taking your RMDs.
You no longer have to calculate the withdrawals yourself because each custodian must calculate it for you; therefore, the IRS will know how much you are supposed to withdraw (and pay tax on). If you simply follow the numbers given by each custodian, you may be doing yourself a disservice. Why is that, you may ask?
Well, let’s say it’s 2009 and you have money in several IRAs as many people do. One IRA is mostly invested in stocks, another is in bonds and another is in cash. If you remember, in 2009 your stock portfolio lost 40 percent of its value. If you blindly followed the redemption amounts from your custodians you would have satisfied your RMD by taking money from the stock account at the worst time.
Remember, you can’t put money back into an IRA, you can only withdraw. So, a better choice would have been to leave the stock account alone and, instead, withdraw the RMDs from the bond and cash accounts. Now, this is an extreme case, and let’s hope 2008 doesn’t happen again, but the point is, each year a careful study should be done before you take a withdrawal from you IRAs.
In most of the media, you will only read about the best way(s) to grow your money because they are not practicing financial planners and they have no expertise in harvesting money. That’s too bad because, actually, harvesting can be more important than growing a portfolio. If you’re young, you have plenty of time to make up for investment mistakes. If you’re old; you don’t.
So, the “when” of taking RMDs is now, towards the end of the year. This is because you want your money to stay in a tax deferred account a long as possible. But don’t wait until December 30 because you might miss the year-end deadline and have to pay a penalty. The amount that the RMD is based on is the December 31 value of the prior year, so you have plenty of time.
The “how” of taking RMDs is not as easy as the when. Actually, it’s pretty complicated because it begins with your cash flow needs, then looks into taxes, investment assumptions and long-term planning, so make sure you are well prepared for this important life event.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual.