Jan 18, 2017

Why a 60-Year-Old Needs to Think About Being 70

By Byron Ellis

If you have been saving money for the last 20-30 years you most likely have accumulated a pile that sits inside a retirement plan or IRA. These types of plans may have allowed you to invest pre-tax dollars over the years and some of you enjoyed a company match. Now it is the primary place you draw from to create your income during retirement. The tax deferral benefit all these years may now be turning into a hindrance since you may have to pay tax on every dollar that you take out of your plan. I am sure you already know this and I will tell you for sure that the IRS does too! In fact, they have a keen eye on your money and can’t wait to get their hands on it.

The IRS has created a rule that you must follow once you hit 70 ½. They call it Required Minimum Distributions, RMD for short, and it is designed to get them their tax money quicker. At a very high level, the IRS is going to require that you take out a minimum amount from your tax deferred plans. The amount is calculated based on the amount in your plan, your age (or life expectancy) and an assumed growth rate. They essentially are going to force you to pull money out in order to liquidate the account over your lifetime.

I suggest that you do not wait until you hit 70 ½ to see how this affects you. Why? Let’s say that you are currently withdrawing $40,000 out of your IRA each year to live on. Next year you will be required to start your RMD withdrawals so you start to figure out what that will look like. When you do the calculation, you determine that your RMD is going to be $80,000. It is finally sinking in...you realize that you are going to have to take out double what you really need causing you to increase your taxable income by $40,000. This could be another $10,000 or more in taxes that you are going to be forced to pay. It could be really bad if the amount that you are required to distribute pushes you into a higher tax bracket forcing you to pay a higher percentage to the IRS than you would have otherwise.

So what can you do at 60 to help alleviate the pain?

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The goal for RMD planning is to try to control your tax rate by planning your distributions instead of letting the IRS dictate them totally for you. When you are still 5-10 years out, calculate what your future RMD will look like and compare that to what you estimate that you will need to withdraw for your normal needs. Here are the steps to take:

Estimate the future value of your IRA.

You need to estimate what will still be left in the account when you hit 70 ½, factoring in both investment growth and income distributions. You will find a good calculator to help you do this at https://www.calcxml.com/calculators/how-long-will-my-money-last#.

Estimate what your future RMD might be.

You will need to take the future value from the first step and run a Required Minimum Distribution calculation. You can use the following calculator to do this https://www.calcxml.com/calculators/qua06. You will need to adjust the birthdays so that you trick the calculator into thinking turned 70 ½ this year. Your answer is an estimate of what you will be forced to withdraw when you hit that age.

Estimate what your future withdrawal need will be.

This step will be used to estimate how much you will need to take out of your IRA for your normal needs once you hit 70. If your expenses will pretty much stay the same and you don’t plan on any new sources of income coming in (like Social Security) this is a pretty easy calculation. You just need to assume some inflation rate to allow your income to keep up over the years. If you are expecting a new source of income, which means you won’t have to take as much from your investments, I suggest reducing your current investment income need by that amount. For example, if you expect to start receiving $2,300 in Social Security income just reduce your current need by $2,000 or so. Now you must take the result and factor in inflation (meaning you will most likely need to withdraw more money in the future just to keep up with your same lifestyle). A good calculator for this one can be found at https://www.calcxml.com/calculators/bud01. You can simply enter your entire monthly need in one of the expense fields and then see the impact of inflation on your lifestyle.

Will your RMD force you to take out more than you need for expenses?

Is your estimated RMD amount greater than your future withdrawal need? If so, you may have some work to do. When you are forced to withdraw IRA money you may end up jumping a tax bracket and paying more in tax. In order to reduce that chance, consider setting up a strategy now to withdraw a little more from our IRA each year while you can control how much you distribute. Pay attention to your tax bracket and how much more income you can create without jumping too far into the next bracket. Get some help from your CPA or financial adviser if you need to. Hopefully you have close to a 10 year window to help mitigate future tax issues.

The bottom line is do not wait for your RMD to control you. Take time now so you can control it.

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