How required distributions figure into year-end planning

As 2018 comes to an end, Baby Boomers turning age 70 ½ have to worry about required minimum distributions.  RMD’s are challenging to understand and/or easy to overlook particularly for the boomer crowd and their effects on financial planning. 

A recent study by Allianz Life  finds many Americans want a convenient way to handle RMDs that helps offset taxes, leaves legacy.

“For some consumers, RMDs have long been thought of as a necessary evil,” said Paul Kelash, VP of Consumer Insights, Allianz Life. “The government mandates that people take them, even though many find they don’t need the money for every day expenses. So consumers face the challenge of managing the impact on their taxes while being unsure of how to use the leftover funds.”

Kelash discussed the following tips for those Boomers aging out as we enter the year 2019.  Even though most respondents to the RMD Options Study are aware of RMD’s, , the vast majority say they don’t need them, and a full one-third said they find it difficult to understand the impact RMDs might have on their taxes. Given the fact that mismanagement of RMDs could result in people being bumped into a higher tax bracket, it’s crucial that Americans are proactive in determining how to handle their RMDs.

Here is what you need to know.

Boomer:  What are Required Minimum Distributions?

Kelash:  Required minimum distributions (RMDs) are funds that the federal government requires people to withdraw from tax-deferred retirement accounts – like traditional IRAs and 401(k)s – once they turn 70 ½. Each person’s RMD is a set amount of money that must be taken from each qualified account every year, which then becomes part of their taxable income. Taking an RMD is usually a manual process, and it is up to the owner of the account to understand the amounts that need to be taken, as well as the deadlines. They are then responsible for contacting the companies that their IRAs or 401(k) accounts are with to make the withdrawal. This is true even for a 401(k) from a company someone worked at 20 years ago and haven’t rolled over or touched since. There are several caveats though, like if someone is still working at age 70 ½, they won’t have to take RMDs from their current employer’s 401(k) plan.

Even though they are somewhat obscure and complex, according to the recent RMD Options Study from Allianz Life Insurance Company of North America, the majority of high net worth Americans between the ages of 65 and 75 are actually familiar with RMDs on tax-deferred retirement plans. However, a full 80% of these respondents believe they will not need all of their RMDs for day-to-day living expenses. This can potentially leave these Americans feeling unsure of how to use this money and confused about how it may impact their finances, particularly their taxes.

Boomer:  What effects can RMDs have on my finances?

Kelash:  Like death and taxes, you can’t avoid RMDs. All consumers with an IRA or 401(k) reaching the age of 70 ½ will face the impact of RMDs, which can be significant if not managed properly. First and foremost, an excise tax can hit you. That tax equals 50% of the total RMD amount if you don’t take the RMD, or you take an insufficient amount. Also, since RMDs are considered part of your total taxable income, they have the potential to bump you into a higher tax bracket, which can be a substantial, expense if you don’t plan for them carefully.

Although most people were aware of RMDs, 32% in our study found it difficult to understand the impact RMDs might have on their taxes. Additionally, 71% said they are interested in using RMD payments to fund a financial product that could help offset the impact of taxes, and the vast majority (95%) of respondents believe it is very important to reduce their taxes in retirement.  

Boomer:  How can I handle the taxes on my RMD’s and use them in a way that works with my larger financial strategy?

Kelash:  RMDs are complex, especially if you have multiple qualified accounts to manage. So seeking a financial professional’s help is always a good option to avoid making a mistake for those taking RMDs or preparing to do so. They can help find solutions to manage RMDs more efficiently and use them in a way that works with their larger financial strategy. This could include planning income streams in retirement, minimizing their tax impact, or potentially utilizing RMDs to leave a legacy. In fact, half of the study respondents said they are interested in leaving a significant portion of their RMDs to beneficiaries, with consumers aged 71-75 expressing the most interest in leaving a legacy.

Our study also found that people want the RMD process to be automatic. As people age and their capacity to handle complex financial topics declines, the headache of RMDs becomes a bigger challenge. Sixty percent from our study would prefer not to have to deal with RMD payments and what to do with the money they have to withdraw, and over half (57%) want the disbursement and tax payment to occur without getting involved.

Bottom line, it’s important to create an income plan that incorporates RMDs. Working with a financial professional takes some of the burden off. They can help you see the full picture and evaluate how to balance your RMDs and Social Security payments in a way that lessens the negative impact of taxes.

Nearly 80% of those who work with a financial professional feel they have gotten good advice from them about managing their RMDs. If you haven’t discussed RMDs with a financial professional, now is a great time to do so. Planning ahead can help ensure you’re doing the right thing before, during and after the RMD process starts so there are no unwelcome surprises come tax season.