Investors who have hit RMD age may be feeling hit hard by this year’s market troubles.
The IRS requires investors to take required minimum distributions (RMDs) from tax-deferred retirement accounts to ensure tax liabilities aren’t put off indefinitely. The minimum annual withdrawal is meant to be calculated using the account balance as of December 31 of the year prior. In December 2021 the S&P 500 Index hit an all-time high. A few months later, the market started to take a downturn. Even though many investors' portfolios have depressed, they’re still required to satisfy RMDs based on their peak portfolio values. This can be stressful when individuals face a 50% penalty if RMDs are missed.
So what can you do when you’re facing high RMDs on top of market losses? Read on for tips on how to maintain control of your account balances during difficult times.
If you Have the Option, Delay.
If this is your first RMD or you’re still working you may have the option to delay. RMDs usually must be taken by December 31, however, your first RMD can be delayed until April 1 of the year after you reach the relevant RMD age (72 if you were born after June 30, 1949 and 70½ if born before).
Alternatively, if you’ve reached the age of taking RMDs but are still working you may also be able to defer taking the RMD from your current employer’s retirement account. In the past, the IRS has allowed an individual’s first RMD from an employer’s retirement plan to be taken by April 1 the year after you retire. The only requirements are that your company allows you to delay past the RMD age and you own less than 5% of the business.
If you choose to delay, you’ll still be required to hit that year’s RMD prior to December 31, which means you’ll be taking two distributions in the same calendar year. As a result, your taxable income may increase, which could also push you into a higher tax bracket. Just be sure to think through the tax implications before officially delaying.
Convert to a Roth IRA
Another strategy is to roll over some savings into a Roth IRA. Roth IRAs do not require RMDs, unlike traditional IRAa or Roth 401ks. It’s important to note that contributing to a Roth IRA won’t lower your taxable income, but you do not have to pay taxes on withdrawals from earnings if you are over 59½ and you have had the account open for more than five years. You should also be aware that moving pre-tax money from a retirement account into a Roth IRA requires you to pay taxes on those funds all at once.
The main advantages to this strategy are that your money can stay in a Roth IRA and grow tax-free for as long as you wish, as well as not needing to pay taxes on withdrawals. We advise, though, to consult a financial professional to determine if this option is right for you.
Figure Out What to Sell
If you need the RMD funds to cover current funds, the goal is to do as little harm to your portfolio as possible, which means sellings assets and offloading investments may be necessary. You may want to consider rebalancing your portfolio by selling overweight positions and replacing them with underweight positions more in line with your target allocation. This is a disciplined approach to raising cash and keeping your portfolio working towards long-term goals.
You should also consider which individual investments need to be sold. Look at any holdings with weak prospects or those that no longer match your goals. It may also be beneficial to discuss with a financial advisor to assess what’s best to sell and avoid locking in losses on positions that have suffered the worst.
Give to Charity With a QCD
If you’re not in need of the income yourself and charitable giving is part of your financial strategy, consider a qualified charitable distribution (QCD). This not only helps you reach your philanthropic goals, but can also reduce the tax hit from RMDs. A QCD allows individuals 70½ to donate up to $100,000 to charity from your IRA and count it toward your RMD. The charity has to be deemed qualified by the IRS. Additionally, RMDs that you donate to a cause or group cannot be deducted for your taxes as a charitable contribution; the IRS does not allow you to have the tax break both ways.
Top Off Your Short-Term Reserve
It’s always beneficial to have a cushion to help manage risks no matter the condition of the market. It’s advised to hold a year’s worth of anticipated withdrawals in cash investments such as checking or savings accounts, money market funds or CDs, with an additional two to four years’ worth of conservative investments.
“In-kind” Transfer of Securities
An additional option if you don’t need the cash flow is to transfer securities from your IRA to your after-tax brokerage account. This is particularly beneficial if you don’t want to part with an investment. While this strategy doesn’t help you avoid taxes on the RMD, it can reduce transaction costs while maintaining position in the security. It’s important to know this in-kind IRA distribution does reset the cost basis of your investment.
If you did have to make a withdrawal to satisfy your RMD, you always have the option to reinvest in a taxable brokerage account in the hope of making up for lost gains. Although, there is no up-front tax break and capital gains will be taxed the year they’re recognized. If the asset is held for more than a year, you may qualify for a lower long-term capital gains tax rate. There are also tax-efficient investments that have the opportunity to offer tax benefits such as municipal bonds. However, if you’re satisfied with your current holdings, in-kind distributions are largely considered a better option.
Many retirees who have hit RMD age may be feeling stressed this year, however there are a number of ways to go about cushioning the blow of the current market while maintaining control of your account balances. Sometimes, the best option is to consult a professional. Our professionals at NJM Wealth Preservation Strategies create uniquely structured portfolios, tailored to your specific situation and long-term goals.
If you’re looking for a true retirement income financial professional, NJM Wealth Preservation Strategies can help. If you’re ready to get the most out of your investments, schedule a call with us here today
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