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Savvy IRA Planning for Baby Boomers - Rollovers, Distribution, & Withdrawals

Savvy IRA Planning for Baby Boomers - Rollovers, Distribution, & Withdrawals

| January 04, 2021
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So, last time we talked a bit about the basics of IRAs and Roths. 

This time I want to go in a bit more depth about these plans and options you have in terms of rollovers, distribution, and withdrawals.

Let’s start with…

Six “Rollover” Options for Your Plan Funds

So at some point, you’re likely to retire, and when you do, you’ll be faced with one of your first major retirement decisions... what to do with the money you’ve accumulated in your employer-sponsored retirement plan.

In many cases, people choose to roll their funds over to a traditional IRA or Roth IRA, because they tend to offer greater control over one’s retirement funds. They are not the only options, though, and such rollovers are not always the best move.

Believe it or not, you may have as many as six different options for your employer-sponsored retirement plan funds when you leave work. You can see them here on the screen. Each of these potential alternatives offers unique benefits and drawbacks, so it’s usually a good idea to discuss your options with a knowledgeable professional so that you can make the savvy decision that’s right for you and your family.

Taxation of Retirement Account Withdrawals (Non-Roth)

Alright, getting money into your retirement accounts is only the first half of the story. Coming up with an efficient way of taking those funds out, and avoiding costly mistakes, is the other half. This is far easier said than done, particularly when it comes to your traditional IRAs, 401(k)s, 403(b)s and other pre-tax retirement accounts. 

In general, withdrawals from these accounts are taxed at ordinary income rates, just like interest. Your withdrawals are added to your income and taxed at whatever tax bracket you happen to find yourself in. If your overall income is relatively low, you might have a low tax rate for your withdrawal. On the other hand, if your overall income is higher, your tax rate will be higher and more of your IRA withdrawal will end up in Uncle Sam’s hands. Here’s a quick look at the tax brackets for single and joint filers for 2020.

Top Income Tax Rates Throughout History

One of the troubling aspects of IRA planning is that the tax rate on your future distributions is unknown. Even if you can project your income with relative confidence, there’s no guarantee that tax rates will remain the same. And while it’s hard to find someone who doesn’t think they pay too much in taxes now, the reality is that the top tax rates today are pretty low in a historical context.

Take a look at this chart to see what I mean. 

When the income tax was first introduced in 1913, the top rate was only 7%, but within just a few years, the top rate had already skyrocketed to over 70%. After dropping back down to as low as 25% after World War I, the top rate jumped to 63% in 1932. From there, it wasn’t until more than 50 years had passed when, in 1987, the top tax rate finally dropped back below 50%, letting those in the top bracket keep more of their income than they were forced to give over to Uncle Sam. 

Now, of course, not everyone pays that top rate. In fact, it’s only a very small percentage of taxpayers that do. That said, with our national debt at all-time highs, a budget that hasn’t been balanced in years and fiscal troubles for many of our entitlement programs like Social Security and Medicare, it’s possible that rates could go up across the board. That makes coming up with the right plan even more important. 

Potential “Side Effects” Of IRA Distributions

To make matters even worse, your IRA withdrawals can cost you in a lot more ways than just adding to your income. They can also cause you to be phased out of itemized deductions, personal exemptions and various tax credits. They can increase your exposure to the 3.8% surtax on investment income. 

If you take an IRA withdrawal, you might have to include more of your Social Security benefits in income and your Medicare Part B premiums can increase. And that’s just the beginning. If you want to try and avoid these issues, then you need a plan.

Required Minimum Distributions (RMDs)

One way to minimize the tax impact of retirement account withdrawals is to avoid taking withdrawals altogether. That allows your retirement money to grow tax-deferred and keeps that nasty taxable income off your tax return for as long as possible. You can’t put off taking withdrawals forever, though. 

Once you turn 72, the law requires that you begin to take what are known as “required minimum distributions,” or RMDs for short, from your traditional IRA. The same rules generally apply to employer-sponsored retirement plans, like 401(k)s, too. 

RMDs are simply the bare minimum you are required to take from your retirement account each year to satisfy the tax code’s rules. 

If something about RMDs at 72 sounds a little weird to you, don’t worry. It sounds weird to me too! That’s because prior to this year, RMDs generally began once you reached 70 ½. But guess what? This is another one of those changes that was made right at the end of 2019 via the SECURE Act.

Unfortunately, those new rules are only effective for individuals turning 70 ½ or older in 2020 and beyond. So if any of you turned 70 ½ last year, you still have to take an RMD this year, even if you’ll only be 71.

And just to add a little more confusion, the CARES Act eliminated RMDs for IRAs for 401(k)s and similar defined contribution plans for 2020. 

Remember that you can always take more, but if you fail to at least take the minimum amount (in years other than 2020), the IRS can actually hit you with a 50% – that’s five-zero-percent – penalty for any amount that you should have taken, but didn’t.

Calculating Your Required Minimum Distribution

To calculate your RMD, you need to know two things, your prior year-end balance and your life expectancy factor. Getting your prior year-end balance is usually pretty simple. In most cases, you can look at your December or fourth quarter statement and use the ending balance. Then you use your age to look up your life expectancy factor on a special table provided by the IRS, and divide your prior year-end balance by that factor. 

For example, suppose you’re calculating your 2020 RMD. Now we know 2020 RMDs are eliminated, but let’s just use it as an example. 

The first thing you need is your prior year-end balance, so let’s imagine that your December 31, 2019 IRA balance was $200,000. That’s part one. Next, you’ve got to figure out your life expectancy factor. Most IRA owner’s use what’s called the Uniform Lifetime Table to calculate their RMDs. 

So let’s imagine that you turn 75 this year. Now, we simply go to the table below and look up the factor for a 75 year-old. 

As you can see, the factor for a 75 year-old is 22.9, so to determine your RMD in this hypothetical example, we divide $200,000 by 22.9 and get $8,733.63. Then each successive year, you do the same thing, take your prior year-end balance and divide it by your new life expectancy factor. Not too bad, right? 

RMDs As A Percentage Of Your Account Balance

Of course, most people don’t think about things in terms of factors or life expectancies, so here’s a chart I think you’ll find helpful. 

It shows the approximate percentage you need to take out of your IRA from 70 to 89 in order to steer clear of the 50% penalty. If you look, you’ll see that each year, the percentage you need to take out increases. That doesn’t necessarily mean you need to take out more money each year than the last though, as that also depends on how much your IRA gains – or loses – from year to year.

And just to be clear about why the first few rows here are different colors; the age-70 row is red and crossed out because NO ONE needs to use that RMD percentage any more (unless you missed an RMD that year, but that’s a whole different ball of wax). 

The second row for age-71 is yellow, like a caution signal, because most of you won’t need to use that RMD percentage ever either. In fact, the only people in this room who would need to do so are those who turned 70 in the first half of 2019!

Finally, you see the age-72 row in green. And that’s because that’s where most of you will start taking Required Minimum Distributions. 

3 Common RMD Mistakes

RMDs can actually get much more complicated and, as we’ve already discussed, the penalties for making a mistake can be pretty severe. With that in mind, let me tell you about three of the most common RMD mistakes people make, so that you can avoid them. Remember, part of any savvy IRA plan is minimizing costly mistakes. 

One common RMD mistake people make is incorrectly aggregating their RMDs between different types of retirement accounts.

For example, suppose you have a 401(k) and an IRA, and after calculating your RMDs from each account, they come out to be $4,000 and $3,000 respectively, for a total of $7,000. Now imagine your IRA is earning a higher rate of return than your 401(k). You might be tempted to just pull out $7,000 from your 401(k), leave your IRA alone, and call it a day. After all, what’s the difference? They’re both retirement accounts and whether you take $7,000 from just your 401(k) or $4,000 from your 401(k) and $3,000 from your IRA, it’s the same impact on your tax return. 

That’s pretty logical thinking, but the tax rules are anything but logical and they specifically prohibit you from doing that. An RMD for one type of retirement account, like an IRA, can never be taken from another type of retirement account, like a 401(k).

Another common RMD mistake is aggregating RMDs between spouses. For instance, suppose you and your spouse file a joint tax return. You have an RMD for your IRA of $4,000 and your spouse has an RMD for their IRA of $2,000. To make things easy, you simply take $6,000 out of your IRA. After all, they are both IRAs and since you file jointly, the income will show up on the same return, right? 

While that may be true, it doesn’t matter. Retirement accounts are individual accounts. There’s no such thing as a joint IRA or joint 401(k), so you must always take your own RMDs from your own accounts.

A third common RMD mistake is forgetting to take an RMD altogether. Although this should never happen, sometimes mistakes are made. It’s just a fact of life. Maybe a family member was sick and you got preoccupied. Maybe you were away on your dream vacation and it simply slipped your mind. 

Whatever the reason, if you forgot to take an RMD, or you’ve otherwise made a mistake, the one thing you should not do is forget about it and pretend that it never happened. In most cases if you do that, the IRS can come back and assess the 50% penalty, along with a host of other penalties and interest, indefinitely. 

So now we have covered more about distributions. Next time we will cover some savvy strategies when dealing with your distributions, reducing risks, conversions, and more.

Don’t hesitate to send me an email if you have any questions about anything covered here at!

Advisory services through Capital Advisory Group Advisory Services LLC and securities through United Planners Financial Services of America, a Limited Partnership. Member FINRA and SIPC. The Capital Advisory Group Advisory Services, LLC (CAG) and United Planners Financial Services are not affiliated.

The views expressed are those of the presenter and may not reflect the views of United Planners Financial Services. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Neither United Planners nor its financial professionals render legal or tax advice. Please consult with your accountant or tax advisor for specific guidance.

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