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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Why Not Use Dividend Stocks For Retirement Income?

Why Not Use Dividend Stocks for Retirement Income?

Today we answer a viewer question about using dividend stocks to create retirement income.

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Our question from Ronald. He writes:

I am looking to retire soon and trying to determine the best way to generate retirement income with interest rates so low. Traditionally, you could have done this with treasuries or CDs. Why wouldn’t buying dividend stocks paying 4% to 5% makes sense? In addition to the dividends, you have the opportunity for appreciation.

The Challenge of Low Interest Rates

Ron makes a couple of good points. Interest rates are ridiculously low right now. Traditional methods of using bonds or CD’s to generate income are a challenge. Ten-year Treasuries are yielding about 1%. Thirty-year Treasuries yield about 1.8%. CDs, unless you lock those up for a few years, are going to be well below 1%. Using these interest-bearing investments to create retirement income is very difficult.

Using Dividend Stocks For Retirement Income

Why can’t you use a portfolio of dividend-paying stocks to create that income? You can, and there are some benefits. The dividend income is more than you would earn on a lot of fixed-income investments. You also have the opportunity for capital appreciation. Many of these companies will increase their dividends over time. And there are some tax advantages.

The Challenges

1. Volatility

But there are significant challenges to doing this. The first one is volatility. Companies who pay good dividends will decrease in value. You are going to see periods where your account drops 20%-30%. You must be able to withstand those periods, and not sell something at an inopportune time.

2. Portfolio Construction

The next challenge you have is how you build your portfolio. You want to make sure you have diversification across different industries. You want to make sure you are picking good companies.

Oil companies provide a great example of why you should diversify. When oil prices went down last year, many oil companies saw their share prices decrease. Many of them also decreased their dividend. Investing too much in one industry could impact your ability to maintain your income.

Stock selection is also important. Look for companies that have good earnings as well as a decent payout ratio. (The payout ratio is how much of the earnings are being paid out as dividends.) If a company is paying more in dividends than they earn, it could be a problem down the road.

You also want to look at their dividend history. Has the company been able to maintain their dividend over time? Have they been able to increase their dividend over time? Or have they had periods where they cut the dividend? When you depend on that income, the last thing you want to see is your income cut.

You want to be cautious of owning too few companies. When you own too many shares of one company, bad news could hurt your account.

3. What if You Need Extra Income?

You may find you need extra income. This can also be a challenge. You can sell positions that have appreciated in value. But when you sell those shares, your future dividend income is going to decrease. It can create a problem if you do need extra income. One of the ways to address that challenge is to have a bigger emergency fund on hand. When you need extra income, use your emergency fund and not disrupt your regular income flow.

Tax Advantages for Using Dividend Stocks to Create Retirement Income

This can be a tax-advantaged way to generate income in a non-IRA account. Qualified dividends receive preferential tax treatment. For most people, qualified dividends get taxed at 15%. It could be lower, depending on your total income. Other types of income are taxed at higher rates.

Qualified dividends come from common stocks of US companies and some international companies. When you build a portfolio of common stocks, you are going to be in a more tax-advantaged position.

Some higher-yielding investments pay dividends that are not qualified. Real Estate Investment Trusts (REIT’s), Master Limited Partnerships, and Business Development Companies pay good dividends. But those payments are not qualified. You can hold those, but you will not see the same tax benefits.

If you can handle all the challenges, using dividend stocks to create retirement income can be a good strategy. But it may not be easy.

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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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Is Gold a Better Investment than Stocks?

Is Gold A Better Investment Than Stocks?

Is gold a better investment than stocks?  Wendy asks, “I keep hearing ads advising us to sell our stocks and buy gold or silver. For an older investor, is this a valid point?” 

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Gold Better Investment Than Stocks

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Gold Better iNvestment than stocks

Is gold a better investment than stocks?  

Gold is one of the ultimate fear assets. When things go haywire in the markets, people tend to turn to gold because it’s a tangible asset, and it has value everywhere.

We’re dealing with the possibility of hyperinflation. If that happens, gold could do very well. Another shutdown could increase the fear level of investors. Gold could also do well in that case. There are periods of time, like early 2020, where gold really shined.

Fact or Myth? Gold is safer than stocks

You have a gold bar locked in the safe. You paid $1,500 dollars for it. Unless you pay attention to gold prices, you know you have a gold bar and it has value. You may not know how much it’s worth, but it’s going to be worth something to somebody.

If you pulled it out earlier this year and thought to yourself, “I wonder how much this is worth?”, you discovered it was worth $2,000. Then, you put it back in the safe until next year. The next time you think about the bar, it could be worth $1,500. It could be worth $1,200.

Gold has extreme fluctuations in value, just like stocks. Let’s look at the last 13 years.

  • 2013 -28%
  • 2014 -2%
  • 2015 -10%
  • 2018 -2%.

Over the same timeframe, stocks were down

  • 2008 -37%
  • 2018 -4%.

Over 13 years, gold lost money four times, and stocks were down twice.

If you look at the last 48 calendar years, gold experienced declines 18 times. Stocks fell 11 times.

Gold is not a “safer asset” than stocks.

Is gold better than stocks?

Here is a link to a good article called, Gold’s Romantic Delusion. There’s a graph in that article which shows $10,000 invested in gold in 1980 versus $10,000 invested in stocks. On July 31 2020, the gold would have been worth about $36,000. Stocks would have been worth $761,000.

Is Gold Better Than Stocks

Source: Gold’s Romantic Delusion by Andrew Hallam.  Click here for the full article

Is it a better asset than stocks for older clients, or any client for that matter? In our opinion, no. The numbers say the opposite. Gold isn’t a bad investment, but I wouldn’t own gold instead of stocks.

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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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How Do I Use My Savings To Create Income?

How Do I Use My Savings To Create Income?

Tim asks,”How do I use my savings to create income in retirement?”

In this episode, we’ll talk about:

  • Immediate Annuities
  • Bonds
  • Dividend Paying Stocks
  • Systematic Withdrawals

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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:

Transcript: How Do I Use My Savings To Create Income?

1. Immediate Annuity

This is an insurance contract that creates an income stream for the rest of your life. You can add survivor benefits to this so it will be the rest of you and your spouse’s life. It’s guaranteed by the insurance company and their ability to pay.

Advantages

Eliminates market value risk

This eliminates any market value risk. There are no worries about the stock market going up or down.

Better payouts

You usually will get a higher payout than using the 4% rule. Immediate annuities typically pay out a greater percentage.

Income you can’t outlive

It will pay as long as you or you and your spouse are alive.

Disadvantages

Lose control of your principal

You lose all control of your principal. So if you need more income or a lump sum in the future, you likely won’t have access to the principal for those needs.

Fixed Income

The payout is typically a fixed amount. There are a few contracts out there that will provide some inflation adjustments. But those contracts will reduce the initial income benefit to account for the annual increase.

No Legacy

When you and your spouse have passed, there is no money to leave to your heirs. If you buy the contract, and two months later something tragic happens, that money is gone. There are a few policies that have refund provisions. But, that provision could reduce your monthly income.

Low Interest Rates

Low interest rates mean smaller payments. When interest rates increase, this will be a more attractive option.

This may be a reasonable choice for part of your savings. I wouldn’t recommend anyone put all their savings in one of these contracts.

What we often find is most people don’t like giving up control of their principal. And we believe there are better ways.

2. Income Producing Investments

You can also use income-producing investments. This means bonds and dividend paying stocks.

Bonds

Bonds pay an interest payment. Unfortunately, bonds are not a great choice right now. You might be able to find good interest payments on some bonds, but you have to pay a high premium for them. This means when the bond matures, you’ll get less than what you paid to buy the bond. Newer bonds won’t have good interest rate payments. This limits your income stream. Bonds also offer little or no appreciation potential.

Dividend Paying Stocks

Dividend paying stocks make sense. Over time, dividends tend to increase. There is also potential to see your principal grow

Constructing a portfolio that can generate a 3% yield or higher can be a challenge. You want to buy good dividend payers. This means companies that reliably pay their dividend and increase their dividends.

You can do it, but you introduce other variables. There’s risk for concentrating too much in a particular stock. Dividend cuts can create problems. This isn’t a risk-free strategy.

The last thing to consider is most people don’t want to be 100% invested in stocks. So that can limit your income as well.

Systematic Withdrawals

The third way is to use systematic withdrawals. This is one of the better inventions by the mutual fund industry. Over time, you sell shares of your investments to create income. It’s a very simple process.

You don’t have to use mutual funds to do this either. It can be done with exchange traded funds or individual stocks. You sell shares to produce your income.

You can combine this with a dividend strategy too. If you own a company that doesn’t pay a dividend, you could sell shares to supplement the dividends you get.

Here is something to remember when you’re looking at producing income. Snow or rain, it’s all water. If the “snow” represents dividends and the rain is “capital appreciation”, it all benefits you. It doesn’t matter if your income is from dividends or from selling shares.

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3. Managing Taxes

You also want to think about your taxes. If you have many sources of retirement funds, you have that ability. Distributions from Roth IRAs, for example, are tax free. Income from a personal or joint account may be more tax friendly. Distributions from IRAs and pre tax 401k plans are taxed as ordinary income. Most of the time, 100% of those distributions are going to be taxable. When you have separate sources of savings, you can manage your tax liability to some degree.

Unfortunately, for many people, their only asset for retirement income is their 401k. This limits your ability to manage your tax bill.

It can help to talk to an advisor about your situation. They can help you with a strategy that makes sense for you.

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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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Do You Need $8 Million to Retire?

Do You Need $8 Million To Retire?

Do you really need $8 million to retire? This is one of those articles that makes you scratch your head and say, “Where is this coming from?”

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Do You Need $8 Million to Retire

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Do You Need $8 Million to Retire?

Transcript: Do You Need $8 Million to Retire?

The article appeared last week on marketwatch.com. It was titled,  The New Savings Target for a Modest Retirement: $8 million? The article is based on a blog post written by someone who calls himself the Financial Samurai. The Samurai believes that the 4% Rule is dead. The actual safe withdrawal rate is 0.5%. Let’s dig into this.

Using the 4% Rule

The 4% Rule is something that a lot of financial advisors use. It starts the conversation about how much income you can generate from your retirement savings. You can use the rule to set a savings goal, or you can use it to determine how much income your savings will provide.

If you’re trying to set a savings goal, determine how much income you’ll need from your savings. If you need $40,000 from your nest egg, multiply $40,000 by 25. Your target is $1,000,000. (4% of $1,000,000 is $40,000 a year.)

Do You Need $8 Million to Retire?

Perhaps you’re getting close to retirement. You’re wondering how much income you can expect to get from your 401k. You’ve saved $500,000 in your 401k. Multiply that by 4% and you get $20,000 for the first year.

$8 million to retire

If you use 0.5% to compute your savings goal, it changes the math significantly. Instead of needing a million dollars to create $40,000 of income, you’ll need $8,000,000!

More on the 4% Rule

This video and blog post goes into greater detail about the 4% rule. 

Is This Realistic?

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Your $500,000 401k with a 0.5% withdrawal rate creates $2,500 of annual income. That’s a little over $200 per month.

Do You Need $8 Million to retire?

Is This Realistic?

Is this half percent safe withdrawal rate, the “new normal”? We disagree. We believe the 4% Rule is a valid tool to use to start the income conversation.

Academic minds developed the 4% Rule by studying past return data for stocks and bonds. The researchers were looking for a withdrawal rate with a very high level of success. We define success as not running out of money during your lifetime.

They tested it through all types of extreme market events. This includes bear markets like the “dot com” bust, the Great Recession, and the early 1970s. The 4% Rule held up in all those circumstances. It doesn’t mean it will hold up going forward. It’s not guaranteed.

Higher Withdrawal Rates Increase Risk

We know this. As you increase your withdrawal rate, you increase the chances of running out of money. You increase the odds of significant spending cuts because of adverse market conditions. The 4% Rule is not a silver bullet. We don’t know what future returns will be. But the 4% Rule remains a good starting point. The pandemic, an over-valued stock market, or low bond yields don’t change our opinion.

You don’t need $8 million to enjoy a modest retirement. People can retire and live a happy life on far less. They figure out ways to make it work.

The 4% Rule is a baseline. We work from there based on each individual’s circumstances to create a plan.

Do You Need $8 Million To Retire?
Do you Need $8 Million to Retire
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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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