Required Minimum Distributions

Required Minimum Distributions

Today we discuss required minimum distributions and cover:

  • when you have to start taking them
  • why it’s important to take them
  • the basics of how they’re computed
  • when during the year is the best time to take your distribution
  • and, what you can do with the money if you don’t need the income

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Required minimum distributions may not be an interesting topic, but our clients ask a lot of questions about them. If you’re heading towards your retirement, it’s something that should be on your radar.

When do you have to start taking your required minimum distributions?

In 2019, the government passed the SECURE Act. This legislation increased the age at which you have to start your required minimum distributions. It used to be the year you reached age 70½.  Now, you must start the year you reach age 72.

Why do you want to take your required minimum distributions?

If you don’t take your RMD, the penalty is severe. The penalty is 50% of the shortfall. If your required amount is $10,000 and you fail to take that, the IRS penalty is $5,000.

required minimum distributions

How much do you take the first year?

Your first RMD is roughly 4%. The IRS uses the Uniform Lifetime Table. It is a life expectancy table which uses a 10-year difference in age between spouses. If your spouse is more than 10 years younger than you, you can do things differently.

You look up your age on the table find the divisor. The first year the divisor is 25.6. (25 equates to 4%.) The next year, the divisor goes down a little bit, which means the percentage increases.

Required minimum Distributions

Here is an example. The balance of your IRA at year’s end is $256,000. Divide that by 25.6. The amount you have to withdraw is $10,000. Next year, you divide the year-end balance by 24.7. The following year, you divide the year-end balance by 23.8. You always take the balance at the end of each year and divide it by the number for your age.

Eventually, you will take more from the account than you can earn. At age 88, the amount is about 8%. At age 92, the required amount is roughly 10%.

Required minimum Distributions

When is the right time to take your distribution?

Some clients take their RMD early in the year. Others wait until later in the year. Many people worry about what is happening in the investment markets. If the stock market is near all-time highs, a lot of people will want to take it at that point.

We do not know what will happen later in the year. Values could be higher or lower than they are right now. The correct answer to this question is, “take the distribution when you need the money.”

Income Taxes

Most custodians will withhold taxes from your IRA distribution. Most will withhold both state and federal income taxes. If you pay quarterly estimates, you should adjust your estimated tax payment.

What if you don't need the money?

One of the better planning tools you can use is a qualified charitable distribution. You direct a distribution from your IRA directly to a charity of your choice. You do not report the distribution as income. You will save both the state and federal income taxes on the amount that you donate.

The other thing you can do is reinvest your distribution in a taxable account. Many custodians allow you to transfer shares of an investment to another account. This is an “in kind” transfer. You can also transfer cash.

You cannot convert your required minimum distribution to a Roth IRA.

Benefits of Using a Roth IRA

There are no required minimum distributions from Roth IRAs. It’s another great reason to use the Roth IRA to help you save for your retirement.

These specific rules only apply to the original account owner or their spouse. If you have an inherited IRA, different rules apply to you.

Talk to a Certified Financial Planner™ Professional

If you have specific questions about your situation, a financial planner can help. Talk to one today.  Click below to schedule a call

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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How Retirement Income is Taxed

How Retirement Income is Taxed

How Retirement Income is Taxed

Today we look at how the most common types of retirement income are taxed.  We look at:

  • The common types of accounts retirees use
  • The types of income taxed at the highest rates
  • Types of income which receive favorable tax treatment

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When you retire, you go from earning a paycheck to using your savings to create a paycheck. You will still have to pay income taxes. Today, we look at the common types of accounts retirees use to create income, and how they are taxed.

Retirement Plans and IRA's

This might be a 401k, a 403b or even a 457 deferred compensation plan. Many people roll those over into an IRA.

The taxation of the income generated from those accounts depends on the contributions. If you made pre-tax contributions—meaning you took a tax deduction—the income is taxable. Your contributions, your employer’s contributions, and the earnings are taxed as ordinary income. Tax rates for ordinary income start at 10%. The maximum tax rate is 37%.

If you used the Roth type accounts, the contributions happened on an after tax basis. This means withdrawals from these accounts are not taxed.

Individual and Joint Accounts

The second type of account that retirees use is an individual or a joint account. If you have this type of account, you pay taxes “as you go”. The investments in those accounts often pay dividends or interest. Interest is usually taxed as ordinary income. Dividends paid by a common stock get favorable tax treatment. In most cases, the highest tax rate for qualified dividends is 15%.

You may also have capital gains. A capital gain happens when you or one of the investments you own sells an investment. If you own a mutual fund, that mutual fund may buy and sell stocks and bonds inside the mutual fund. The gains pass to you as a shareholder.

If you own an individual investment, and you sell those shares, you can generate a capital gain as well. If you owned the position for at least a year, the gain is a long-term capital gain. Long-term gains get favorable tax treatment. The highest capital gains rate is 20%. Most people will pay 15%. The full amount of the sale is not usually taxed. Taxes are due on the amount above what you originally paid for the investment.

This can be a factor if you are using a systematic withdrawal. This strategy involves selling shares of your investments to generate monthly income. Part of the income is going to be taxable, and part of it is going to be return of your principal. The taxable part may get taxed at lower rates.

Pension Plans

The other type of account used to create income in retirement is a pension plan. If your company offered a pension plan, the income is taxable as ordinary income.

Annuities

Another common type of account is an annuity. If you annuitize a contract, part of the income is taxable. The balance is a return of your principal.

Social Security

The last type of income source that’s taxable in retirement is Social Security. We will cover taxes of Social Security benefits next week.

Talk to a Certified Financial Planner™ Professional

Knowing how taxes impact retirement can help you plan for a better future. If you have questions or concerns, talk to a financial planner.

 


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About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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What Should I do With My Old Retirement Plan?

What should I do with my old retirement plan?

Today we answer a question from Adam.  He asks, “I changed jobs a couple of months ago.  What should I do with my old retirement plan?

We discuss:

  • Your options
  • The pro’s and con’s of each
  • The key factors in your decision
  • And what you should ask a financial advisor about a rollover

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Do you want to hear the full show?

The full episode is over 25 minutes long.  And we’ve found that not everyone wants to spend that much time listening to things.  But if you want to listen to the entire episode, it is below.

We answer:

  • What should I do with my old retirement plan?
  • Can I use a trust to protect Mom’s assets if she goes to a nursing home?
  • Should I use my employer’s new Roth 401k option.
  • How do I use my savings to create retirement income?
  • Can I make the maximum contribution to both a Roth IRA and the Thrift savings plan?

Transcript: What should I do with my old retirement plan?

If you have changed jobs and left a retirement plan behind, you’ll have four options.

  • You can leave it in your old employer’s plan.
  • You can potentially roll it over to your new employer’s plan.
  • You can roll it over to an IRA.
  • Or, you can take a distribution

Leave it in your former employer's plan.

Advantages

  1. Cost. Your former employer’s plan may be one of the lower cost options. If that’s the case, then it may make sense to leave it there.
  2. Familiarity. You’re also familiar and comfortable with how the plan works.

Disadvantages

  1. Adds Complexity. Leaving your money in the plan makes it harder for you to keep things organized.
  2. Limited Investment Choices. With any retirement plan, your investment choices can be limited. You don’t have as many options to invest your money. Most plans have enough options to help you achieve your goals.
  3. Lack of Help. It may be difficult to get the help you want when you need it. You’re stuck calling a call center.

There aren’t many advantages to leaving it where it is.

Roll it to your new employer's plan

If your new plan allows it, you can roll it over to your new employers plan. Some plans don’t allow this.  You’ll need to check to see if your current plan does.

Advantages

  1. Simplicity. This can help you keep things organized. And it will help you see how you’re making progress towards your goals. That’s the biggest advantage.

Disadvantages

  1. Cost: You need to look at the cost of the plan. If it’s more than what you would pay in an IRA or your former employers plan it may not make sense to roll it to your current plan.
what should i do with my old retirement plan
old retirement plan what should i do

Roll it over to an IRA

You can do this many ways. You can work with a financial advisor, a bank, or insurance company. You can also use someone like Vanguard, Charles Schwab or TD Ameritrade.

Advantages

  1. Control. You control every aspect of that IRA. You control the investment choices and the cost.
  2. Nearly Unlimited Investment Choices. There are very few restrictions for what you can own in an IRA.
  3. Access to the Money. Some retirement plans may restrict your access to the money. You’ll have complete access to your money in an IRA.

Disadvantages

We can’t think of any disadvantages to this.

Take a distribution

This is probably the worst option, unless you’re in a dire financial situation. A distribution means taxes and penalties when you withdraw the funds.

Key factors in your decision

Costs

There are costs for any of these choices. Some costs are hidden. These are the internal costs of investment choices. Some of those are very low, some of them may be a lot higher.

Every plan has mutual funds or exchange-traded products. Those have an internal expense structure. In some cases, you may incur record keeping costs.

Many employers pass record-keeping costs on to their plan participants. They have to disclose it to you and it will appear on your statement.

Some plans have management fees. These also have to be disclosed. These will also appear on your statement. An IRA may have management fees, especially if you work with a financial advisor.

There could be other costs, too. You might pay commissions. If you select an insurance contract, you will likely pay a commission. You may also run into things like surrender charges, and other expenses for things like annuity contracts.

Control

IRAs allow you to control your situation. Retirement plans are more limited in that regard. They have limited investment options and limited access to your money. IRAs give you complete access to your money and complete control over the investments.

Convenience and Simplicity

Money is complicated enough. The more complications you add, the harder it is to reach your financial goals. You want to have it someplace where you can keep an eye on things and monitor your progress.

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what should i do with my old retirement plan

Financial advisors and rollovers

Financial advisors make their living from retirement plan rollovers— including us. There is going to be a cost to you to do this when you hire a financial advisor. It may be more or less than what you currently pay.

Conflicts of Interest

This cost creates a conflict of interest. When an advisor prompts you to complete the rollover, it doesn’t matter if they’re a fiduciary or not. Whether they charge a commission or management fee, it doesn’t matter. Any financial incentive for the advisor to help you roll over your balance creates a conflict of interest.

But, if you see the value to having someone help you and the value is worth what they charge, hire that advisor.

Ask Questions

You need to ask relevant questions. Know how your advisor is going to be paid for that rollover. Is it going to be a commission or is it going to be a management fee? Know if what you’re going to pay is a one time charge or if it is ongoing.

And you need to know what other costs you’re going to incur. What types of investments is that advisor going to use? Are there surrender charges? Are there other hidden fees?

Be prepared and understand how the relationship will work.  Make sure you are comfortable with every aspect of the person you hire. 

If you would like to talk to us, please click here to schedule a phone call.

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Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

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Should I Take Money From My 401k Plan

Should I Take Money From My 401k?

“Should I take money from my 401k to help me get through these tough times?” That’s a question we received from a listener.  The CARES Act made some changes to these distributions.  But there are still some things you should consider. Let’s dig into the answer. (Read more below)

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It’s a tough time right now. We’re all trying to stay healthy. That has led to some very extreme measures. And those measures have created some financial hardships for people.

Mark sent us a question. He asked, “should I take money from my 401k to help me get through these tough times?”

How the CARES Act changed 401k distributions

Recently the federal government passed the CARES Act. It is a $2 trillion stimulus designed to help Americans weather this storm created by the Covid-019 virus.

One of the provisions of this act was to provide some tax relief for distributions from 401k plans and other retirement accounts like IRA’s.

Should I Take Money from my 401k

Normally, if you are under age 59 1/2 there is a 10% penalty for early distributions. The CARES Act now waives this penalty for those early withdrawals up to $100,000.

The act also allows you to spread the taxes from any of those distributions over 3 years.

Lastly, you can return those distributions to your IRA or 401k inside the three-year period as well.

Check Your With Your Employer!

Not every 401k plan allows for in-service distributions. Please check with your employer.

Are You Ready to Retire?

If you are 50 or older, and thinking about your retirement.  Click here for a free retirement assessment.

But, should you take money from your 401k?

Now, this doesn’t answer Mark’s question. It shows that it is an option. Should you tap into your 401k (or IRA) to help you through these tough times?

Here are some things to consider?

Should I take money from my 401k

Your distribution is taxable…

The distributions are still taxable. Even though you can spread the tax bill over three years, and there is no penalty, there are still taxes due. Think of it this way, for every dollar you take out, at best you’ll only keep 85 cents.

You’re selling at lower prices…

The stock market is down significantly. Selling now, means you’re going to lock in those losses.

There is a future cost…

You worked hard to save it. Taking those funds from your account not only has a current cost, it has a potential future cost as well. You’ll miss out on the future growth. Over time that could be significant.

A last resort…

Withdrawing from retirement accounts should be a last resort. Unfortunately, a lot of people could reach those extreme situations. The government has at least provided a little relief if it gets that far.

Make sure you dig into your numbers before you make these tough decisions. If you need some guidance, talk to a financial planner.

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3 Things You Should Know About Bear Markets

In this free guide, we’ll share 3 things you need to know about bear markets, and 4 things you can do right now to survive it.

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  • No cost or obligation to you.
  • A detailed look at your retirement picture.
  • A plan to make your retirement better.

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The Best Reason To Not Sell Your Stocks Now

The Best Reason To Not Sell Your Stocks Now

If you haven’t sold your stocks at this point, you may not want to.  Sure, the market could drop further. But selling now could be a big mistake.  Today, I’ll share the best reason to not sell your stocks now.  (read more below)

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Why Sell Now?

The sole reason to sell stocks at this point is to keep your balance from shrinking further. We never truly know (in advance) where the bottom is. And we may not have seen the bottom of this bear market yet. 

Not Sell Your Stocks Best Reason
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But selling at this point could end up being a big mistake. Here is the best reason to not sell your stocks now.

Bear Market Math

The foundation of our reason is rooted in what we’ll call bear market math. How much return do you have to earn to recover all that was lost during the downturn?

The Best Reason To Not Sell Your Stocks
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Let’s say the market only dropped 20%.  To erase the losses, you would have to earn 25%.

Right now, the current bottom of this bear market is about 34% lower than the all-time high. From that point, you have to earn 51% to erase the losses.

And if this bear turns uglier and drops say 50% from its February high, you’ll have to earn a 100% return to break even

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"Safe Assets" Offer Very Low Returns

Selling those stock holdings now and moving to the so-called safe assets can be a big problem.  In today’s environment, the potential future returns for those types of investments are very low. You might find a 6 month CD with a yield of 1%. 12 month CD’s are only slightly better. And we all know most of our savings accounts don’t even pay that much. Those low returns make recovering your losses very difficult—if not impossible.

And those prospects look even worse when you consider what happens to the shares of those companies immediately following the bottom of a bear market.

Catching the Rebound

This is our 15th bear market since the end of World War 2.  Here’s what happened following the bottom of the bear markets:

Click the graphs to enlarge

  • The average price increase 1 month after the bottom was almost 31%.
  • When we look 6 months out from the bottom, the average price gain was nearly 26%.
  • 12 months after the low point, the average price increase was 39%.
  • And 2 years after a bear market bottom, the average price increase was nearly 60%.  

And remember, this is only price increases.  It doesn’t factor in the additional returns from dividends!

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It Happens Early...

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This is interesting.  Prices one month from the bottom were higher than they were 6 months later in every single recovery.  A major portion of the recovery happens very early.  Missing out on that could have a significant impact on your future.

These gains may not have erased all the losses in any of those bear markets. But the surge immediately following the bottom helped those who stayed invested–even if their accounts fell further—recover a lot faster than if they moved to “safer havens.” And this is the best reason to not sell your stocks now.

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Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.  This is now his 5th bear market.  Unfortunately, it won’t be his last.

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Avoid These 4 Big 401k Mistakes in 2020

Avoid These 4 Big 401k Mistakes in 2020

One of the biggest factors in your long-term financial success is avoiding the big mistakes. Unfortunately, we see many of the same common errors that—over a person’s career—can cost thousands if not hundreds of thousands of dollars. Try to avoid these 4 big mistakes in your 401k in 2020

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Mistake 1: Not Maximizing Your Match

Many employers will match your 401k contribution.  If you put money in your account, your employer will too.  We typically see that amount range between 3% and 6% of your pay. 

Unfortunately, we see people who won’t maximize their employer’s match.  Not only are you not receiving all the pay you should, the long-term impact on your nest egg can be huge.    

Mistake 2: Not Saving Enough

Most financial planners suggest you should try to save between 10-15% of your pay for your future. In fact, the amount you save is the biggest factor in your long-term success.

Unfortunately, we see people who limit their savings level well below that. Often times, people will cap their savings in their 401(k) at the point where they maximize the employer match. For most of us, this probably won’t be enough to have the type of retirement we want.

Mistake 3: Not Pursuing Growth

A Nobel Prize winning economist once did a study that showed financial losses feel twice as bad as financial gains feel good. As a result, many people get more conservative with their savings than they should. This means they don’t put enough money in stocks.

Not being aggressive enough can lower your returns over time.  This actually adds more risk to your long-term plans.

Mistake 4: Withdrawing Money From Your 401k

Whether you change jobs or take an in-service distribution, withdrawing money from your 401k gets very expensive.

Most times we see this when people change jobs. Instead of rolling their balance to an IRA or their new employer’s plan, they withdraw the money. This results in taxes, early withdrawal penalties, and the loss of future compounded growth.

If your plan allows for in-service distributions, the costs will be similar.  Most of those distributions will be taxed and penalized.  The penalty applies when you are under age 59 ½.

How Much Will These Mistakes Cost?

How much will these mistakes cost you?  The numbers can be shocking.  The longer you have until retirement, the bigger the cost.  We have a special webinar where we illustrate the potential cost of these 4 mistakes. Click on the button to watch.

What's On Your Mind?

Do you have a question about what’s happening in the world of finance or investing?  Is there a topic that has you curious?  We’d love to hear from  you.

 We’ll do our best to answer it in a future episode.  To submit your question, fill out the form.  If you prefer, you can send us an email directly.  That email address is neal@flemingwatson.com

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Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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