The notion of a standard retirement age may be fading, but there's still one age--701/2--you really can't ignore.
At that age, owners of most workplace retirement savings plans and traditional individual retirement accounts must begin drawing down those accounts and paying taxes.
You can delay the first withdrawal until April 1 of the next year, but subsequent withdrawals must come out by year-end. Still working? You can delay taking required minimum distributions in your workplace plan but not in your IRAs.
For some, required minimum distributions are moot because they already are taking more than the minimum to pay living expenses.
Others would rather not take them at all. In fact, the requirement was by far the most cited reason for taking IRA withdrawals among people 70 and older in survey data reported in a September paper by Investment Company Institute researchers.
The wealthy can avoid them this year under the Pension Protection Act, which allows donations up to $100,000 to go directly to charities to satisfy the requirements.
But what about those in the middle, living off pension and Social Security income now, but who will need that minimum-distribution money as an inflation hedge or an emergency fund for old age?
Broadly, they need to think about how shifting more assets into taxable accounts will affect their long-term portfolio strategy, as well as their tax bite.
New retirees are sometimes so enamored by their lower tax brackets that they fail to plan for minimum distributions, said William Reichenstein, a Baylor University professor.
"Most people withdraw from their taxable accounts first in retirement, which is good," he said. "But if they're doing that to the extreme, they aren't using all of their low tax brackets when they can."
Take a sixtysomething couple in the 15 percent tax bracket bringing in $50,000 in taxable income this year. That meets their expenses, so they haven't touched their IRAs, even though they have been eligible to take penalty-free withdrawals since age 591/2. They might consider drawing $10,000 annually out of their IRAs before they have to take required minimum distributions, Reichenstein said, keeping them within the same bracket.
Why? Drawing down the account today lowers the overall balance, so when it comes time for mandatory withdrawals, they, too, are lower. And that means less chance the minimum distribution will throw you into a higher bracket later on.Want to do more? Assuming you qualify (with adjusted gross income for married couples or singles under $100,000), you could convert chunks of your account to a Roth IRA, which isn't subject to required minimum distributions, said Robert Keebler, an accountant with Virchow, Krause & Co. in Green Bay, Wis. You would pay income taxes on the withdrawals, but after conversion to a Roth they would grow and be withdrawn tax-free.
"You can put a big dent in your [future] minimum distributions by methodically converting to a Roth," Keebler said.
Keith Piken, managing director for personal retirement solutions for Bank of America in Boston, said more retirees are warming to the idea because it relieves heirs of future taxes.
But paying income taxes early may sound counterintuitive, as it does to Trey Bizé, a financial planner in Oklahoma City. "Don't give anything to the IRS until you have to," he said.
For many people, he said, the withdrawals won't represent enough money to make much difference in their tax planning.
(You can run your own numbers with this free calculator that estimates your required minimum distribution, which is based on government tables tied to life expectancy: www.dinkytown.net/java/RetireDistrib.html.)
Through required minimum distributions and elective withdrawals, most retirees will convert substantial amounts of money from tax-deferred to taxable accounts over time, and that creates an opportune time to make sure the right types of investments are in the right accounts, said Kevin Gahagan, a financial planner with Mosaic Financial Partners in San Francisco.
"It's not uncommon for people to have a lot of growth assets like stocks in their tax-deferred accounts and income assets in their taxable accounts," Gahagan said.
As you begin to take distributions, it's a good time to reposition, he said, so that bonds and real estate investment trusts, which generate gains that are taxed as ordinary income, go into the retirement accounts that will be taxed as income.
That leaves stocks in your taxable account, where they qualify for lower capital gains rates.
Fill those accounts with individual stocks or total market index funds with low turnover to minimize capital gains exposure, said Baylor's Reichenstein.
Just don't forget to balance the overall portfolio according to your risk tolerance. Asset allocation still trumps location, he said.
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