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.

Talk to a Certified Financial Planner™ Professional

 


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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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A Stock Market Crash is Always Coming

A Stock Market Crash is Always Coming

A stock market crash is always coming.  

A good friend of mine sent me an article last week written by the folks at motleyfool.com. Four Reasons the Market will Crash in the Next Three Months.

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The reasons they gave were:

  • Increased restrictions due to the virus
  • The vaccine euphoria would evaporate. (Remember in the last quarter of 2020, the stock market got a big boost on the vaccine news.)
  • Democrats would win the two Senate races in the Georgia runoffs. (This already happened.)
  • And history repeating itself.

Here’s the truth about the stock market.  The stock market goes up, it goes down, and then it goes back up, again. There is always a crash of some magnitude coming.

Crashes are Normal

Your definition of a crash and my definition of a crash are probably two different things. To me, a crash is a significant drop. What we saw last spring, that was a crash. Others include:

  • The “dot com” bust
  • the Great Recession
  • 1987
  • And the end of 2018, when the market dropped almost 20% over the course of three months.

You can look at the data going back into the 1920s and see that market crashes happen all the time.

Annual Corrections

The average calendar year correction since 1980 is -14%. The smallest was -3%. And the small corrections are rarer than the bigger ones.

The largest was -47%. That happened back in 2008. Last year, the correction was -35%. It was the second-worst drop in the last 41 years.

These events happen regularly. What is more important is what happens after the crashes. The stock market’s total return in 2020. was +18.4% last year. It erased the losses and produced a gain of almost 20%!

A stock market crash is always coming

Over the last 41 years,

  • There has been a drop of -10% or more at least 23 times
  • the market has gone down by more than -14% 16 times
  • and the compounded average annual return over the 41-year timeframe is +11.9% per year.

Stop and think about what has happened over the last four decades.

Despite all that happened, the stock market rewarded investors with an 11.9% average annual return.

Don’t worry about the headlines. You can write these stories every month from here to eternity. The crashes are going to happen. History shows us time and time again, those who weather the storms are rewarded.

Talk to a Certified Financial Planner™ Professional

 


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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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Taxing Social Security

Taxing Social Security

Today we talk about taxing Social Security. We will discuss:

  • the factors that go into determining whether your Social Security income is taxable or not
  • give you some examples, and
  • tell you about a few potential surprises that you may encounter.

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Taxing Other Types Of Retirement Income

Last week we discussed how other types of common retirement income are taxed. Click Here to watch that episode.

Today, we focus on taxing Social Security benefits. For some people, your Social Security may be taxable. Here is how we can determine if your benefits will be taxed.

Provisional Income

It starts with your provisional income. To determine if your Social Security is taxable, you’ll need to compute this. It includes:

  • half of your Social Security
  • dividends
  • interest, both taxable and non taxable
  • earnings
  • pension income
  • IRA distributions, and
  • other income

If your provisional income is less than

  • $32,000, for a couple
  • $25,000 for a single person,

your Social Security benefits are not taxed.

But if your provisional income is between

  • $32,000- $44,000 for a couple
  • $25,000- $34,000, for a single filer,

50% of your Social Security income is taxed.

And if your provisional income is over

  • $44,000 for a couple
  • $32,000 for a single person

85% of your Social Security benefits is taxed.

Examples

John and Carol

John receives about $27,600 in Social Security benefits and Carol receives $21,600. That totals $49,200. Half of their benefit is $24,600. They receive $2,000 a month from John’s IRA, for a total of $24,000. Total, they earn $5,000 per year in dividends and another $1,500 in interest.

Their provisional income is $55,100. This means 85% of their Social Security benefits are taxable.

taxing Social Security

Mary

Mary was recently widowed. She receives $21,600 in Social Security, half of which is $10,800. She takes a required minimum distribution from her IRA which was $8,300. Her provisional income in this case is $19,100. This is below the $25,000 threshold, so her Social Security benefits are not taxed.

taxing Social Security

Carl

Carl is single. He receives $2,000 per month from Social Security, $24,000 total. Half of that is $12,000. He also gets about $2,000 in dividends and $1,000 in interest. The rest of Karl’s income comes from a Roth IRA. He takes $50,000 from his Roth account. His provisional income is $15,000.  His Social Security benefits will not be taxed.

The Roth IRA distributions do not add to his provisional income.This is an additional benefit of using a Roth IRA in your retirement planning. Distributions from the Roth are not taxed. They also won’t make your Social Security benefits taxable.

taxing Social Security

Potential Surprises

Change in Marital Status

The first surprise is a sudden change in your marital status. If you find yourself suddenly single, you may owe more in taxes. The income limits for single people are lower than those for married couples. A sudden change in marital status may lead to more of your social security benefits being taxed.

Change in Income

A sudden increase in your income can also have a hidden surprise. This normally happens when you reach the age for required minimum distributions. At age 72, you have to start taking money from your IRA account. This will add to your provisional income. The distribution may cause your Social Security income to be taxed

Talk to a Certified Financial Planner™ Professional

There are a lot of factors that affect your taxes in your retirement, and you can manage some of them. Talk to a financial planner to learn more.

 


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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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Save More or Pay Off Your Mortgage?

Save More or Pay Off Your Mortgage?

As you get closer to retirement, should you save more or pay off your mortgage?  This was a question we received from a listener.  Let’s look at the key factors of your decision.

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Today we have a question from Laura. She writes, “My husband and I will be 52 years old this year. Should we focus on saving more for retirement or paying off our mortgage?”

Why Pay Off Your Mortgage Before You Retire?

Your mortgage payments are typically one of your biggest expenses. Not having that expense frees up money for other things or reduces the stress on your savings. We like to see people not have a mortgage when they go into retirement.

An Example:

Laura and her husband need $2,000 per month from savings to cover their expenses—including their mortgage. Using the 4% rule as a basic guideline, they would need about $600,000 in savings.

save more or pay off mortgage

Their mortgage payment is $800 per month. If they pay off the note before retirement, they would only need about $1,200 per month from savings. Using the 4% rule, this means they only need about $360,000 in savings. It is a significant difference.

Save More Pay Off Mortgage

What Factors In Your Decision?

If you are trying to determine whether you should pay more on your mortgage or save more, ask these questions:

If you keep your mortgage payment the same, will your mortgage be paid off by the time you retire?

If the answer is yes, consider adding extra funds to your retirement savings. You may want to think about using a Roth IRA, Roth 401k, or other types of after-tax savings? If the answer is no, you may want to dig a little deeper.

Will paying more on your loan eliminate your mortgage by the time you retire?

If the answer is yes, consider paying extra on your note.

How much have you already saved and how much are you saving towards retirement?

If you have been a good saver and have a good foundation, it’s easier to favor paying extra on your loan. But if you have not been a good saver, you may want to place a higher priority on your savings.

Talk to a Certified Financial Planner™ Professional

There are a lot of moving parts to this and it is a great thing to discuss with a financial planner. They can help you build a strategy that makes sense for you and helps you achieve the best possible outcome.

 


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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 is Tax-Loss Harvesting?

What Is Tax-Loss Harvesting?

A listener asks a question about year end tax planning.  Can tax-loss harvesting help your tax situation?  Today we look at this strategy and how it works.

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What is Tax Loss harvesting

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What is tax-Loss harvesting

Today we answer a question from Joanne. She writes, “Last week I heard about something called tax-loss harvesting. What is it, and how can we benefit from it?” This is a strategy you can use to reduce your tax liability.

Understanding Capital Losses

From time to time, investments will decrease in value. And they may decrease to a level that is below your cost basis. Your cost basis is what you paid for the investment, plus any dividends reinvested into that position.

If the market value drops below your cost basis, you have an unrealized capital loss. You realize that loss when you sell it, and that can help reduce your income tax liability.

How Capital Losses Affect Your Taxes

First, losses offset any capital gains. Capital gains happen in two ways. They happen when you sell something for a profit. If you own a mutual fund, the fund may pay a capital gain distribution. The fund creates gains when the fund buys and sells securities.

An investor sells shares of Amazon for a $10,000 profit. They also sell shares of Ford for an $8,000 loss. They would only pay capital gains taxes on $2,000.

Loss-Harvesting

If your losses exceed your gains, you can use those losses to reduce other income, up to certain limits. You can use $3,000 of capital losses to reduce your other income each year. Any excess gets carried forward to future years.

Our investor sold shares of Amazon for a $10,000 gain. They also sold shares of General Electric for a $15,000 loss. You would not incur any capital gains taxes this year. They can use $3,000 of the remaining loss against their other income. The investor would have to carry $2,000 forward to use against their taxes next year.

What is Tax-Loss harvesting

Planning Tip

This does not apply to any investments in an IRA, 401k, or other types of qualified plans. You are not paying capital gains taxes on anything you buy and sell in those accounts.

Wash Sales

If you are harvesting a capital loss, you can’t buy the same investment you sold for a loss within 30 days. Doing so creates a wash sale. The IRA will not allow the loss on your taxes. If the stock you sold has a sudden increase in price, you can miss out on the gains.

Keep Good Records

If you have a large capital loss, it could take a long time to carry it forward. You will need to keep very good records.

There is Still Time for 2020

You still have time to harvest capital losses for this year. Any sales made between now and December 31 count on this year’s taxes. But you should speak to your tax professional to see what kind of impact those will have on your situation.

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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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Obstacles To Your Retirement

Obstacles To Your Retirement

What are the biggest obstacles to retiring when you want to? Whether you are two years from retirement or 20 years, we all face similar obstacles. Today, we discuss the three biggest obstacles to your retirement.

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Obstacle 1: Health Insurance

Many people would like to retire at 62 or younger. But there is a big problem. Health insurance at that age can be very expensive. Depending on where you live, premiums for health insurance can cost between $1,200 and $1,800 per month, per person. That means $2,400 to $3,600 for a couple. You can also expect those premiums to increase a significant amount each year.

The coverage may also not be as good as what you currently have. Many policies have high deductibles and limited options for providers and hospitals. You also may not have prescription coverage.

What can you do to overcome this obstacle?

Delay Retirement

The most obvious answer is to wait until 65 to retire. At that point, you are eligible for Medicare, which is a lot less expensive.

Dedicated Savings

If delaying retirement is not an option, maybe you want to consider saving more. Consider creating a dedicated account designed to cover your health insurance premiums. If you already have a health savings account, that may be a way to help. But you want to be careful using your HSA. You cannot use your HSA to pay for health insurance premiums if you deduct or claim a tax credit for those costs on your return.

Take More Income from Savings

The other thing you can do is to take more income from savings early in retirement. Doing this can add risk to your nest egg. If your investments struggle, a higher withdrawal rate could create problems.

Obstacles to Your Retirement
Obstacles to Your Retirement

Obstacle 2: Mortgage Debt

The second major obstacle is mortgage debt. It tends to be one of the larger items in your budget. According to the Employee Benefit Research Institute, people between the ages of 65 and 75 spend on average $21,000 per year on housing costs. More people are retiring with mortgages than they did 10 years ago. A mortgage can be a significant part of that annual total. How can you overcome this?

Prioritize Paying Off Your Mortgage

If you have a few years until you retire, make paying off your mortgage a higher priority. Saving is important , but eliminating this debt will improve your retirement cash flow.

Many people earn more on their savings than what they pay in interest. But the impact of compounding returns over five or ten years isn’t as significant. Paying off the mortgage can have more long-term value to you when thinking about your retirement.

Refinance Your Loan

You may want to consider refinancing your house, especially right now. Mortgage rates in 2020 are as low as they have ever been. Refinancing can reduce your interest rate and spread the payments over more years. This can reduce your payments. It is not ideal, but it’s better than putting too much strain on your nest egg.

Downsize

Consider downsizing. Sell your house and use the equity to buy something smaller where you may not have the debt. You may not need all that space anyhow. Downsizing could also lower your insurance premiums and property taxes.

Obstacle 3: Inadequate Savings

Most people will struggle to retire on their terms because they did not save enough. How can you overcome this?

Save More

If you have a few years before you want to retire, make saving a higher priority. Re-examine what expenses are critical to enjoying life and cut those that are not.

Pursue Growth

Be more growth oriented. Pursuing higher returns can help you accumulate more. This works better if you have a longer timeframe. Remember, there could be some rough periods where things could be very difficult.

Delay Retirement

The third thing you can do is delay your retirement date. Waiting to retire gives you more time to save. It also reduces the discounts to Social Security or pensions.

Consider Working Part-Time

You can also consider other ways to supplement your income such as part-time lower stress work.

Simplify Your Life

Consider simplifying and minimizing your lifestyle. You may have to scale back on some things and reduce expenses to make retirement work.

Your retirement decision is about balancing risks. Increasing the income from your savings increases the risk of running out of money. But, waiting to retire means you have less time to enjoy your golden years.

There are no one-size-fits-all rules. You need to make the right decision for you and your family. And you need to make the best decision you can with all the information available. If you would like help going through the numbers, talk to a financial planner.

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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