The 411 on 2021 Required Minimum Distributions

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Retirees don't have to take their required minimum distributions until year-end. But Morningstar's director of personal finance, Christine Benz, thinks it's a good time to begin strategizing about them.

Christine, thanks for being here today.

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

Dziubinski: Now, many of our retired viewers no doubt know what required minimum distributions are. But let's step back for a minute and define what RMDs are for those who might not be as familiar.

Benz: Right. These are old hat for people who have been taking them for a while. But these are mandatory withdrawals that you're required to take from traditional tax-deferred accounts that would be 401(k)s, 403(b)s, 457s, IRAs. Roth 401(k)s are also subject to required minimum distributions. The big category of tax-sheltered accounts that are not subject to required minimum distributions are Roth IRAs. But basically, these distributions need to begin once you pass age 72, it used to be 70.5 now at least we're at a round number, 72. And you need to take higher percentages of your portfolio as the years go by. So they start fairly low and then scale higher.

Dziubinski: Let's talk a little bit about RMDs and timing. Is there a particular time of year that's better or worse to take your required minimum distribution?

Benz: Well, not really, because the required minimum distribution amount that you're required to take is based on the previous year-end balance. So, for 2021 RMDs, it's based on whatever your balance was at the end of 2020. So, no amount of, sort of, finessing can reduce the taxes that you'll pay and the amount that you need to take out of your accounts. Retirees have different preferences about these matters. I know some retirees like to take them very early to ensure that they don't forget. Other retirees like to save them till later, perhaps to tie in with any sort of year-end portfolio review that they might like to do, and then to enjoy an additional year of tax-deferred compounding on their money. So, there are different schools of thought, different ways of thinking about it. But there's really no one right approach.

Dziubinski: And you alluded to taxes on your RMD.

Benz: Yes.

Dziubinski: Because of course, you will pay them. Are there some tax strategies to keep in mind when you're thinking about taking your RMD?

Benz: Well, potentially so. The big category to consider in this realm is to consider the qualified charitable distribution. And that basically allows people who are older than 70.5, in the case of the QCD, to take an amount out of their tax-deferred account and send it to the charity or charities of their choice, up to $100,000. And that amount that goes to charity escapes taxation, and it also lightens the balance that is eventually going to be subject to RMDs. Once you're subject to RMDs, that's really the single best strategy to consider.

But you can do some strategizing in the pre-RMD years, particularly after you've retired but before RMDs have commenced, and oftentimes there's a little bit of a window if someone retires at 65--between that age and 72--you could potentially consider doing some conversions to Roth during that period. And we said Roth IRAs are not subject to RMDs. So you could do conversions. You might also consider even accelerating your withdrawals during those years if you have a way to keep yourself in a lower tax bracket. So here's a good spot to get some tax advice from a tax advisor about how to proceed. But there are definitely some strategies that you can consider pre-RMD to lighten the tax load once RMDs commence, once you hit age 72.

Dziubinski: You've also written about it and said before that it pays to be strategic about which accounts you take your RMDs from. Talk a little bit about that.

Benz: Right. It really does, Susan, and I love the idea of retirees tying in the RMD process with their portfolio review, with their rebalancing process. Even though you have specific mandates about how much has to come out of your account and that you owe taxes on, there are no rules about which accounts you pull from and which specific investments you pull from. Right now, for example, a lot of retirees have highly appreciated equity assets that they might like to skinny down anyway. As long as you take the correct amount from the right accounts, you can pick and choose where you pull those distributions from. I think this is a great way to improve your portfolio, reduce its risk level, and also satisfy the IRS' rules.

Dziubinski: Christine, let's talk a little bit about the relationship between withdrawal rates and RMDs. What do you say to retirees who might think that their required minimum distribution might be more than what they really want as their targeted withdrawal rate?

Benz: Right. This is a good and common question. And I'm always happy to hear from retirees who are being really conscious about making sure that they're not overwithdrawing. One thing I would say, though, is that the table that most people use to calculate their RMDs is pretty generous from the standpoint of ensuring that you're not overwithdrawing from from those accounts. So specifically, it assumes that you have a spouse who is roughly 10 years younger than you. Many of us do not have spouses who are that much younger than us. So it gives us a little bit of a cushion to ensure that we're not overwithdrawing. And then another key point is that, even though RMDs are saying that your money needs to come out of your tax-deferred accounts, there's nothing saying that you can't reinvest those funds elsewhere. If you're uncomfortable with the withdrawal rate associated with your RMD, for whatever reason, you can put the money into a taxable brokerage account. If you or your spouse have enough earned income to cover the amount of the contribution, you can even put that money into a Roth IRA. There are a couple of workarounds if, for whatever reason, you decide you don't want to spend that money but instead you want to keep it working in your portfolio.

Dziubinski: Christine, thank you so much for your time today. It looks like anytime is a good time to be thinking about RMDs.

Benz: I think so. Thanks, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.