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Last-Minute To-Dos for Retirees at Year-End

Tue, 22 Dec 2015

Don't forget to take RMDs and consider qualified charitable distributions, tax-loss selling, and portfolio maintenance, says Morningstar's Christine Benz.

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Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. There may only be two weeks left in the year, but there is still plenty that retirees can do to improve their financial picture. I'm here with Christine Benz--she is our director of personal finance--for some tips.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: Let's start with the first forget-me-not that you have, which is for retirees who are over 70 1/2. What do they have to keep in mind?

Benz: This is the most important one. If they have traditional IRAs or traditional 401(k)s, they have to take those required minimum distributions out. You calculate your RMDs by looking back to your year-end 2014 balance; that would determine your 2015 RMD. Then, you divide that balance by a divider based on your life expectancy. You can find those tables on the IRS' website. A lot of financial-services companies have calculators that help you do this work. But you have to take those RMDs; otherwise, you will face a very big penalty--not only will you pay ordinary income tax on that amount as you would with any IRA distribution, but you would also owe a 50% penalty. So, you absolutely don't want to miss those RMDs, and you do need to take them by Dec. 31.

Glaser: But you should be strategic about where you go to get them.

Benz: Right. That's why I always say think about your total portfolio at the outset of this process. Think about where your portfolio stands versus your targets for it. And if you determine that you need to lighten up on a given area of your portfolio, why not use your RMD to help lighten up that overvalued or overweight part of your portfolio while also meeting the IRS' requirements.

Glaser: You think that retirees should consider a qualified charitable distribution, a QCD, for their RMDs if they don't need that cash for living expenses. Why is that?

Benz: Absolutely. Congress has been in the habit of renewing this provision in the very latest days of a given calendar year. They just renewed this provision in 2015 in the past couple of days. The good news is that they made this permanent. QCD is a qualified charitable distribution. It simply means that you take a chunk of your IRA and you send it directly to charity. The beauty is that it doesn't hit your adjusted gross income on your tax return. That number determines your eligibility for a lot of credits on your tax return. The lower your AGI, the better. So, by lowering your AGI through the QCD, you put yourself in a better tax position for the 2015 tax year. So, this is good news for charitably inclined investors.

It's also worth noting, though, if you talk to tax professionals, a lot of them will say that investors get a bigger bang for their buck by taking highly appreciated shares out of their taxable accounts and sending those to charity. They get a deduction on those contributions, and they also are able to wash out those large capital gains from their taxable portfolios. So, there are a few maneuvers you can consider here in terms of lowering your 2015 tax bill in the waning days of this year.

Glaser: You said that tax-loss selling should be on a lot of retirees' radars. Why is that?

Benz: Right. It should be on all of our radars, really. The reason is that even though the market maybe is flat for the year to date, I think if investors poke around in their portfolios, they are likely to find that they have at least some securities that are trading at a price below what they paid for them. Among the hunting grounds I would look in would be energy certainly; commodities-related investments are generally down; precious-metals equity is another hard-hit area; emerging markets, the whole gamut of emerging markets, especially Latin America, have all been hard-hit areas where investors may have cost bases that are higher than the securities' current prices.

The beauty of harvesting those losses--actually selling those securities out of your portfolio--is that you can realize those capital losses to offset capital gains that may have occurred elsewhere in your portfolio. So, if you are among the many investors who have gotten socked with a capital gains distribution from your mutual funds, you can use those capital losses to offset those distributions. If you have unused losses, you can use them to offset ordinary income. That's a very valuable maneuver that investors should take advantage of if they have taxable holdings in their portfolios.

Glaser: Maybe on a somewhat related note then, does it make sense to rebalance in these last few days here?

Benz: I think it does, and I would say rebalancing is especially important for retirees, particularly because risk control is generally a bigger concern for retirees than it is maybe for young accumulators. If you are an investor who has been assiduously rebalancing year after year, in 2015 with things kind of flat--maybe a little bit down, maybe a little bit up--you may not have a great need to be rebalancing. But if you're a retired investor and you really haven't made any changes to your portfolio over the past three or five years--you've just kind of been letting your winners ride--it's a good bet that your equity positions are a little bit higher than would be your targets. So, do that check. I really like Morningstar's X-ray tool in terms of getting your arms your portfolio's total exposures. You can look at where X-ray stands relative to your targets and see whether some repositioning is in order.

Glaser: Finally, for retirees who are using the bucket approach to retirement planning, is this the time to refill that first bucket, the cash bucket?

Benz: Well, I always say that this process of bucket maintenance is really important. You don't want to get to the end of a calendar year and have spent all of your cash in bucket one. Ideally, you're refilling it throughout the year as you get your income distributions from your dividend-paying stocks and from your bonds. But if those income distributions were insufficient to refill bucket one, then by all means you do need to look at where else in your portfolio you can potentially peel back on some winning holdings to help refill bucket one all the way. So, I think it's a great time to engage in some bucket maintenance as well as to perhaps restore balance to your total portfolio's mix.

Glaser: Christine, as always, thanks for your thoughts.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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