00:00:03 Benjamin Haas:
Hi everyone and welcome to A/B Conversations where we will help you CFP your way out of it. A podcast where you get into the minds of a couple of Certified Financial Planners on how we think and feel about everyday financial planning questions and what should really matter most to you. A healthier financial life starts...now! Good morning, Adam.
00:00:31 Adam Werner:
Hey, how are you?
00:00:33 Benjamin Haas:
Excellent. How are you today?
00:00:35 Adam Werner:
Fantastic. I know we're going to dive into such a riveting topic that I'm just so amped up.
00:00:42 Benjamin Haas:
I would really appreciate if you would tell the listening audience what we're going to talk about today.
00:00:48 Adam Werner:
So, we just did release one recently on all kinds of the ins and outs on inherited retirement account required minimum distributions, and that's a very specific subset of retirement planning rules. So now we'll dive into the broader. For anybody that has a pretax retirement account, think, traditional IRA, 401k, 403b accounts like that. There will come a time, God willing, that you will be forced to take money out of these accounts and I think a lot of people know that they need to do something, but kind of the inner workings and those details aren't crystal clear. What does that mean to me, right, as the client? I know I have to do something, but what is that? What does that mean to me? What does that mean for taxes? What does that mean for investments, all of these things? And of course, in their infinite wisdom, legislation has been passed and changes these rules, what seems like very frequently these last few years. So those age ranges are now updated from what people may have in their head, from years ago too. We'll kind of just lay it all out and then talk through what are the potential strategies to maybe be more efficient from a tax perspective? Or what are the levers that people can pull? To just have a better feeling or a better handle of what's to come when they get to required minimum distribution age.
00:02:16 Benjamin Haas:
Yeah, and I'm glad we thought about doing this topic because there's really two key things to note here. One, when we use the word taxes, people want to be efficient about that so I think it's really good. Let's go through the strategies on how we can be proactive in our tax conversations but the second reason that's really good to go through this. If you think about all of our clients and I think that's a good subset of the world out there, most people build their wealth in these retirement accounts. They’re setting aside this money, whether it's a traditional IRA, a simple IRA, a SEP, a 401k, 403b, we're going to lump all that into this kind of RMD conversation, but it's just very common for people to come to us and they built their wealth in this bucket. That's going to be taxed and maybe they want to be super sensitive to that in the future. As opposed to, you know, bank accounts or non-retirement accounts. So, it just makes it all the more sensitive to go, okay, when I'm ready to recreate my paychecks, what is that going to look like? But by the way, when I get to this age, not 70 and a half anymore, it's 73, and then it's going to go to 75. But when I get to that age, now there's a minimum, like I'm forced to take a certain amount. I don't have the freedom to decide.
00:03:29 Adam Werner:
Right.
00:03:29 Benjamin Haas:
To a certain degree anymore. So yeah, let's go through it.
00:03:34 Adam Werner:
Yeah. So, then we'll just start with, again, they'll just like kind of lay out the basics. What the heck is an RMD and we'll keep using that term, but RMD is just Required Minimum Distribution. The IRS, the government, is essentially saying you've delayed taxation on this pool of money up until this point and now it's time to pay some tax revenue. So, we're going to tell you that you need to take out at least a portion and just to give people the context typically that first year RMD, it's around four percent. It's a little bit less and those actuarial tables will probably change in the future, but as of right now, it's basically 4%. So, if you had a hundred thousand dollars in a retirement account, the IRS is saying you need to take out 4,000 this year and pay taxes on that money. So it is forced. You really don't have too much of an option at that point. Once you hit that age and you have money in a retirement account, they're going to tell you what you need to take out and when.
00:04:28 Benjamin Haas:
Yeah, all but the Roth IRA as that doesn't have that RMD. The key rule to follow here too is know that December 31st is a trigger date here, right? You have to take it in a given year by December 31st, but then December 31st is also the date which is going to calculate, right? Take that balance. That's going to calculate the next year's RMD. So you can delay it throughout the whole year, must be taken by December 31st, and that valuation is going to trigger next year's calculated amount.
00:05:00 Adam Werner:
Yeah, and then we get people asking us. Well, what if I still don't need it, what if I just don't take it, like what's the downside to that? Can I just leave it in there? Well, the answer is no and the way the IRS incentivizes you to follow through on that RMD is they charge a penalty. It used to be 50 percent of your RMD amount. So, in my scenario, if it was 4,000 of your RMD, they would say, hey, great news, you got to take out 4,000 and you're going to send us 2,000 of that as your penalty for missing it by that December 31st deadline that has been updated along with the age ranges now, or the start dates where you need to take RMDs. They call it an excise tax, but it's now a 25 percent penalty. But here's the good news. If anybody has ever missed their RMD, there is a very simple process. Number one, you need to make sure you take it as soon as you recognize that you haven't done it and then there's a form essentially that you fill out, you submit with your tax return, you can submit separately that just ask for a waiver, ask for forgiveness. You kind of explain here's why I missed it, but I'm going to solve it moving forward and in our experience, we've only done this a handful of times with clients, but we've never had an issue kind of going through that process for anybody who's maybe worried of, well, I'm in the camp where I've missed it. There are steps to go through. If that's you, let us know. We'll certainly help you through that, but it's not the end of the world. There are options there to rectify that.
00:06:24 Benjamin Haas:
Well, I think part of the reason that may happen, it's not uncommon for people to accumulate different accounts over different periods of time in their work and career, right? It used to be that you go to the bank and you, all right, I'm going to put this 4,000 in for this year's traditional IRA, and it's going into a CD. And before you know it, you've done that for 10 years, you got 10 different accounts, let alone different employers, right? You can accumulate a lot. The rule here is your RMD is based on the aggregate balance of all those taxable IRA accounts. So, you are able to take RMDs from just one of the account as long as it satisfies the aggregate. Problem being, if people have money in all different places, it can get cumbersome or something can be forgotten and then do you really know what your aggregate RMD is? So, I think in the times where we've seen maybe some RMDs missed, they're getting an RMD from some account, but they may be either forgot or didn't know they had to be taken from another account.
00:07:24 Adam Werner:
Yeah, I'm glad you brought that up. Cause yes, we've certainly heard, oh, I completely forgot I had this 5,000 sitting in an old 401k from years ago was not factored in to my calculations those first couple of years of RMD. So that's a good point. Let's dive into what can people do to either mitigate the taxes or just maybe think more tax efficiently? Like what are those steps? The one thing that I'll throw out to start, if someone is charitably inclined and they are giving to charity, you're giving to your church, you name it, local organizations. If you're kind of doing that out of your pocket, I think a lot of people know by now that you don't get the tax deduction unless you're itemizing your deductions in any given tax year and now with the standard deduction being as high as it is 25-26,000 depending on how old you are, you would need to gift a lot to charity in any given year to be able to deduct those gifts. Well, here's a way they call it a qualified charitable distribution from your IRA where you can send money directly from your retirement account to a charity, and have that money come to you directly and then you gifted it to the charity, you're going to pay taxes on that withdrawal from your retirement account. By doing it directly from your retirement account to the charity, you avoid that taxation. Sometimes it's a good way that if you're already giving to charity, this is a way that you can gift from your investments, avoid the taxation.
00:08:52 Benjamin Haas:
Yeah.
00:08:53 Adam Werner:
And by the way, hopefully avoid maybe a little bit of future RMD taxation by getting some of that money out of your IRA. It used to be tied to the RMD age of when you could do this QCD, this qualified charitable distribution. So, it used to be age 70 and a half for RMDs. Well now as RMD ages have risen, 72, 73 and to your point, in 2033, going to be age 75. You can still do a QCD at age 70 and a half, even if your new RMD age is 73. So, there is a window of time here where you could still take advantage of this, even if you are not yet required to take money out of that retirement account.
00:09:33 Benjamin Haas:
Well explained. That was a lot. This is good. As I'm thinking too about strategies, I guess it does really depend on, maybe I should have said this earlier. This is a minimum requirement. People certainly early in retirement, right? Like I said, if you've built your wealth, you're more than likely relying on these accounts for income in retirement to supplement social security or a pension or maybe you know other rental income. However, you're recreating your paychecks. So, a lot of these strategies we're going to talk about are maybe if I don't really want to be taking that right? If that minimum amount is more than I would want to be taking, gifting is not a bad idea. As we prep for RMD age, if we're not really wanting to take a lot of that money out if we don't need that, then what we could encourage as a Roth conversion, right? Where there's an opportunity to take some out, pay some taxes but immediately convert that, move that into that Roth IRA bucket, where, you're not forced to take RMDs later in life on that money. And by the way, all that money is supposed to grow tax free, right? So, it should never be taxed again, if you follow all those rules. If you're in that spot where you don't really need the income, great position to be in but don't just sit on your hands and wait for RMD age. Let's consider those Roth conversions and see if there's an opportunity to control your tax bracket a little bit and move some money over there.
00:11:00 Adam Werner:
To your point of, maybe I don't need this, but I know I'm going to be forced to do something with this at some point. So, what can I do at any time? That's a perfect example where we've seen it. There's this window of time. Say somebody retires at 65, but RMDs don't kick in until 73. They may be perfectly fine living off of some fixed income, rental income, whatever investment income, maybe smaller withdrawals from retirement accounts. There's this window of time before you're forced at age 73 or beyond to take money out that I'm going to spread out some of these taxes. I'm going to purposefully take withdrawals or do these conversions sooner than later, just so that I'm not just kicking the can down the road until RMD age kicks in and now my hands are tied. Whatever that RMD is, then at that point, you have to follow it. You have to take it out. So, if not a Roth conversion, sometimes the strategy is just I'm going to take some withdrawals, pay the taxes at today's rates. Again, we don't know where tax rates are going in the future. So that's another variable in this thought process and if I don't need it and I'm not going to convert it to a Roth, I can just reinvest it in a non-retirement account. It can still continue to grow and compound over time. Just not with as much tax benefit as a Roth IRA would. But certainly, more tax efficient than just leaving it in the retirement account fully at that point either.
00:12:22 Benjamin Haas:
Yeah, I'm almost, as you're saying and I'm picturing like you've got this balloon, and it's your tax balloon and it continues to inflate. Like, and you don't want that thing to pop. So, it's okay to just let some little bit trickle out of there and kind of just feel like you're keeping it manageable for later in life. These are very proactive strategies. Both of those situations, it's good to just mock up a tax return, right? Work with your tax professional. We've even got some software to do it. You know, not that it's iron clad, but I think if we make reasonable assumptions on income and what you had as income the prior year, let's map out if we converted or if we took this money out, are we still in a comfortable tax bracket? And I think having that information gives you the power to then say, okay. Yeah of course, why wouldn't I start to spread this out and not, you know, just allow that tax balloon hopefully not to pop much later in life.
00:13:17 Adam Werner:
We've certainly seen it, right. People who have saved into retirement plans, employer plans over time. Somebody could reasonably have a million dollars or more where that percentage becomes much greater, right? On a million dollars. Now you're talking $40,000 of forced income that's going to be taxable. And yes, if you're getting compounding growth in the meantime, that million dollars, of course, can continue to grow. Those RMD numbers continue to get higher and that's where, maybe I'm just illustrating this to drive home the point that it can quickly become a bit of that tax balloon. You don't want that to get to the point where now you're having way too much income that you don't want or need, but you're going to be forced to pay taxes on it. So maybe there's ways to address that. So, the last point here is maybe this, I don't know if we've ever recorded a podcast on this, it's a bit more of an aggressive, I'll say, strategy for people that want to maximize what's going to their heirs, to their kids or grandkids and limit what ends up going to the IRS in terms of that forced taxation on a retirement account. And that's combining the ideas of I need to take this RMD and in this scenario, I'll use those million dollars. I'm going to be forced to take out a large chunk and I don't need it. What can I do? And sometimes we combine that thought with estate planning for that next generation for clients. Essentially what we end up kind of planning for is they're forced to take out this money and they don't need it. What's a reasonable death benefit for a life insurance policy for a couple? It's called a second to die policy where you're spreading out the risk not over just one life but on both lives, and that life insurance policy does not pay out until that second spouse in this case would pass away and that goes to the kids' tax free, and can help them pay the taxes that are going to be due on those retirement accounts in the future. Again, you called it the zero tax plan. It's like the nine circles we can illustrate that in so many different ways. But essentially, try to limit what taxation is forced, not only on yourself, but then also on your kids, on your next generation. I know we talked about this recently, their hands are tied even more so than yours when it comes to RMDs, because they will have a 10-year window and not the rest of their lifetime to kind of stretch out the taxation.
00:15:45 Benjamin Haas:
And I know that's going back to the comment that, if you're in that fortunate situation where you don't really need to rely on these retirement accounts, then that tax bubble is going to continue to compound not only for you, but like you said, and that's what I kept thinking as you're going into the strategy. Then it becomes an estate planning issue because they will have to pay those income taxes. They can only spread it out over 10 years. So that's where the conversation does for us shift back to maybe they already had some life insurance and cash value built over time. Maybe they can leverage that. Maybe we can create something that is going to be better for the heirs, leveraging what can come out of that retirement account. So, let's do a podcast on that sometime. You know, the zero-tax plan is going to bring in a situation where maybe somebody is super charitable too. So let that be the teaser for next time, but this is great. Thank you. I think the big takeaway here is if you know the rules and you've got a little bit of window of time before you're forced to take distributions, then hopefully we shared a couple of different proactive strategies that we should at least talk about, maybe consider.
00:16:48 Adam Werner:
Yeah, absolutely.
00:16:52 Benjamin Haas:
Thanks, sir.
00:16:52 Adam Werner:
All right, till next time.
00:16:54 Benjamin Haas:
You got it.
00:16:56 Adam Werner:
Bye.
00:16:56 Benjamin Haas:
Hey, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only, and are not intended to provide specific recommendations for any individual to determine which strategies or investments may be most appropriate for you. Consult with your attorney, your accountant and financial advisor or tax advisor prior to making any decisions or investing. Thanks for listening!
Investment Advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Haas Financial Group are separate entities. This is not intended to be used as tax or legal advice. Please consult a tax or legal professional for specific information and advice.
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