16
Whenever I speak with investors about the
4%
rule
for retirement-plan distributions, I invariably get
a question about required minimum distributions, or
RMD
s. A number of studies have pointed to with-
drawing
4%
of a portfolio in year one of retirement,
then inflation-adjusting that amount each year,
as being a sustainable withdrawal plan, assuming
a balanced portfolio and a
30
-year time horizon.
But how, they ask, can they possibly adhere to a
4%
withdrawal rate—or even lower—when their
RMD
amounts are well above the
4%
threshold?
They have a good point. Individuals begin withdrawing
less than
4%
of their
IRA
balances in the year in
which they turn
70
1
/
2
, and that percentage quickly
steps up from there. By the time someone hits
73
years old,
RMD
s will amount to more than
4%
of the
total
RMD
balance, and at age
85
,
RMD
s will
consume a whopping
6
.
8%
of the retirement balance.
Those distributions are based on the life expectancy
of the account holder or, if a spouse beneficiary is
more than
10
years younger than the account owner,
on both partners’ life expectancies. Research from
the financial-planning world lends some support to
the notion that you can take out a greater percent-
age of your portfolio in your later years than earlier
on, which is exactly what the
RMD
rules require
you to do.
Nonetheless, some individuals simply don’t need their
full
RMD
amounts for living expenses; they’d rather
keep the money invested so that it can compound and
grow. And they’d no doubt like to keep deferring the
tax bill on their
IRA
assets, too.
Although it’s impossible to circumvent
RMD
s and
their attendant taxes without incurring big penalties,
there’s nothing that says you have to spend that
money, either. Instead, you can keep at least some
of your distribution working on your behalf.
The following strategies can help you maximize the
RMD
proceeds you don’t need for living expenses.
Strategy 1: Look for a Roth Opportunity
If you have unused
RMD
s, the first avenue to investi-
gate is whether you can steer at least part of your
unused distribution to a Roth
IRA
. While traditional
IRA
s don’t allow contributions past age
70
1
/
2
and tax you when you withdraw your money, Roth
IRA
s carry no such strictures. You can contribute
at any age, and your withdrawals will be tax-free pro-
vided you meet certain criteria. The hitch is that
you or your spouse must have enough earned income
to cover the amount of your Roth contribution—
unearned income such as your
IRA
withdrawals,
income from other investments, or Social Security
benefits don’t count.
Even if you can’t make a direct Roth
IRA
contribution
because of the earned-income hurdle, you might still
consider converting at least a portion of your tradi-
tional
IRA
assets to Roth, thereby circumventing or at
least reducing future
RMD
s. Because such a conver-
sion can result in a substantial tax hit, as you’ll owe
taxes on the portion of the converted amount that
consisted of deductible contributions and investment
earnings, it’s important to check with a tax profes-
sional before considering one. Conversions can be a
good fit for some individuals, especially those who
don’t expect to need their
RMD
assets during their
lifetimes and would like their heirs to inherit the
IRA
assets without owing income taxes. (Bear in mind
that inherited Roth
IRA
assets may still be subject to
the estate tax, however.)
Strategy 2: Mimic the Tax Efficiency of a Tradi-
tional IRA
If you want to invest your
RMD
s but deploying your
traditional
IRA
assets into a Roth is off-limits or
doesn’t make sense for one reason or another, you’ll
have to move your unused
RMD
s into a taxable
account. Yet with careful tax management, you can
still largely simulate the tax-deferred nature of
a traditional
IRA
outside of the confines of that tax-
sheltered vehicle. Assuming you’re investing
the money for long-term growth, holding individual
stocks—preferably non-dividend-payers—gives
How to Invest RMDs You Don’t Need
Portfolio Matters
|
Christine Benz
Welcome to our
new feature,
Portfolio Matters,
by Christine Benz, Morning-
star’s director of personal
finance. We’re thrilled to
have Christine help you
manage the portfolio chal-
lenges that you face each
month. Christine will
address personal finance
issues with practical solu-
tions throughout the year.
