Most people don't particularly like being told what to do, so Required Minimum Distributions (RMD's) can easily be resented (at least a little) because they are perceived as "forcing" you to sell investments from 401k/IRA savings, thereby disturbing your invested amounts and creating unwanted tax liability on the distribution.
Perhaps a little planning and a different perspective might help.
It is true that starting at age 73 (age 75 if born in 1960 or later) you are required to take distributions from a
Traditional 401k/IRA. However, there are three factors to keep in mind that may make RMD's more palatable:
• You know in advance how much the distribution will be.
• There is no requirement that any securities need to be sold.
• The amount withdrawn may be immediately, or even simultaneously, re-invested.
The I.R.S. uses a set divisor schedule (based on their life expectancy tables) to determine the percent of savings
that must be withdrawn at a certain age. At age 73 you will be required to withdraw ~3.77% from applicable
401k/IRA savings, with the withdrawal % increasing very slightly each year. If you have multiple accounts this can be taken all from one account, or you can take different amounts from different accounts as long as the total equals
the required % of savings. For example, if you have $1M in retirement savings, at age 73 your total RMD amount would be ~$37,736 (~3.77%). For those that need to use their retirement savings to help pay expenses, this may represent
a "reasonable" amount. If you need to withdraw more than this, the RMD amount is a moot point, but if not, it is within the range of ~3% to ~6% that most advisers recommend as a desirable annual withdrawal rate that will generally allow
your savings to last 25-30 years.
The RMD % does rise slightly as you get older, but keep in mind that your savings may be decreasing at the same time due to previous withdrawals. At age 75 you will need to withdraw 4.07% of your savings, but by then your balance would be ~$916,000, so the withdrawal amount will be ~$37,200, or close to the same as it was at age 73. At age 85,
the RMD % will be ~6.25%, or ~ $32,500. At age 85 you would still have ~$484,000 in your 401k/IRA, plus an after tax amount of ~$400,000 from the RMD's (assuming a fairly "middle of the road" effective tax rate of 12%). Not too bad.
But wait, most likely you would have your savings invested and it would be earning returns. The average RMD withdrawal % from age 73 to age 85 is ~4.85%. If your 401k/IRA savings also earned ~4.85% (reasonable), at age 85 you would have ~$854,000 in your 401k/IRA. If you also saved the after-tax RMD amount in a high-yield savings account (earning 3%?), you would have ~$615,000 in that account. Yes, maybe you make a little less interest in the high yield account instead of the invested 401k/IRA account (depending on your investment strategy), but in total you could still have more than $1,460,000 at age 85! Even earning a more conservative return of 3% in the 401k/IRA (which would change the RMD amounts slightly), you would have ~$690,000, plus ~$562,000 in after-tax savings, for a total
of ~$1,252,000. So, RMD's by themselves will not cause you to run out of savings.
Okay, that sounds great, but let's say that you needed some of the RMD amount for expenses. Same situation as above, except now you save only half of the RMD amount (after paying the taxes). At age 85 you would still have ~$854,000
in the 401k/IRA account (earning 4.85%), and ~$307,000 in the high yield account (~54% of the amount above),
for a total of ~$1,161,000! Makes sense since you only saved half as much as before, and still more than your original 401k/IRA balance of $1M.
RMD amounts are based on the account balance as of the prior year. Since you also know what the required
withdrawal % will be each year (the divisors rarely change), a little planning may improve the situation.
What if you kept the amount that you needed for the RMD in cash, rather than as an investment that you have to sell?
If you stay fully invested, and have to sell securities to satisfy the RMD, you never quite know if you will have to sell at an opportune time, or an inopportune time. If you keep the necessary amount in cash you can let your investments continue to grow uninterrupted. Maybe even keep 2 years of RMD's in cash and only replenish your RMD "cash savings" when the markets are favorable.
Another option is not to sell anything. You can arrange to have securities ownership transferred directly from your
401k/IRA account to a taxable brokerage account. You only need to transfer enough to satisfy the RMD. You will still
incur the tax liability on the value of the transfer, but at least you did not have to sell the securities at a time when you may not have wanted to.
The added advantage of this type of transfer is that if you hold the securities in the 401k/IRA brokerage account for at least a year before selling, your cost basis is as of the transfer date, and any gains will be taxed at the long-term capital gains tax rate rather than the ordinary income tax rate that RMD's are taxed at.
One way or another, if you withdraw money from your Traditional 401k/IRA it will be taxed. RMD's don't make this
any worse. If you take the RMD, and are able to save a good portion of it, again, the actual RMD does not have to be
too much of a negative. Every situation is unique, but you do have options for how best to deal with RMD's.
No one likes to be told what to do, but in the case of RMD's they may not be as bad as they may seem to be:
• You are withdrawing an amount that still lets your saving grow, and more importantly, last, for 25+ years.
• If you don't need the RMD for expenses, or at least not all of it, it can be re-invested to keep that money growing.
• There is no requirement to ever sell any securities to satisfy the RMD.
• Even with conservative returns and 20 years of RMD's, you can still retain at least 2/3 of your original balance -
or much more - if you don't need the RMD's for expenses.
• Use the RMD amount to pay the taxes owed on it and re-invest the remainder. You don't have to spend it!
You do have a few options that can make RMD's work a little more in your favor, if you plan ahead.