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Tips for RMD Season

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Required minimum distributions from tax-deferred accounts like IRAs and 401(k)s took a hiatus last year, but they're back on for 2021. Joining me to discuss what investors need to know about RMDs this year is Christine Benz. Christine is Morningstar's director of personal finance and retirement planning.

Hi, Christine. Nice to see you today.

Christine Benz:
Hi, Susan. Great to see you.

Dziubinski: We did have a little bit of news in the world of RMDs during the past couple of years. First, let's talk about why RMDs were on hold in 2020 and then also talk about when and why the age for RMDs increased from 70.5 years to 72 years.

Benz: Yeah. So, first things first. The hiatus in 2020 was driven by that market sell-off, which feels like a distant memory now, but at the time, we had that calamitous market sell-off at the beginning of the pandemic. And the idea there--and this has happened before, there's precedent for this--the idea is that RMDs go on hiatus to keep retirees from having to invade their IRAs, 401(k)s when they're down in the dumps. So, they will leave more of the account in place to recover when the market eventually does. So, that was in place as of March of 2020.

As far as the age change, that was part of the Secure Act that was passed into law in late 2019, and it brought the age limit up to a nice even number, which certainly is an improvement from my standpoint. But also some people had been lobbying for an age increase because of life expectancies increasing. And so, the idea there is that if that starting date is a little bit further out that that leaves more of the IRA in place for retirees later in life. So, that was kind of the foundation of that. And the net effect of that was that new RMD-takers were able to take advantage of that hiatus in 2020 but also the extension in the age.

Christine, what do first-time RMD-takers need to know?

Benz: Well, they need to know that they need to take their RMDs because the penalty is really steep if you miss an RMD. It's equivalent to 50% of the amount that you should have taken but didn't take. So, you don't want to monkey around with it. But I think it's important to note that you do have some flexibility about when you take the RMD within a given year. So, you base your RMD amount on whatever your account's value was at the end of 2020. That's already baked. You can't affect the amount of your RMD later on after the end of that tax year. So, if it's better for you to take it early in the year, fine. If you wanted to wait until later in the year, that's OK, too. But you do have some flexibility there as well.

I would point out that first-time RMD-takers do have a little bit of wiggle room to take their first RMD on April 1 of the year following the year in which they turned 72. So, if someone turned 72 in 2021, they actually have until April 1, 2022, to take that first RMD. It's usually not advisable to do that, though, because they'll also need to take another RMD in 2022 for the 2021 tax year. So, get some tax advice, but that's usually not a great strategy, even though it might seem like a good idea to delay that first RMD.

Dziubinski: You've often talked in articles and prior videos with us that you think it's important for people to try to strategize where you're taking your RMDs from. Talk a little bit about that.

Benz: Yeah, I think this is so underdiscussed, Susan. So, as long as you take the right amount from the right accounts, it doesn't matter which specific investment holdings those withdrawals come from. So, I always say, use RMD season as an impetus to restore some balance to your portfolio. For many investors, they've enjoyed really strong equity market performance and they may want to skinny down their equity holdings a little bit, given that the stock market has performed so well for so long. Especially if you have a specific holding that has really shot out the lights, perhaps you could concentrate your distributions there, leave things that haven't performed as well intact or potentially even shift things around and add to them, but pull your RMD from the holding that you wanted to scale back on anyway. And by the same token, you can also look at trouble spots within your portfolio. Maybe there was some holding that you just didn't want within your portfolio. There's been a manager change, or you had some other impetus to sell it. Use RMDs as a catalyst to do that improvement of your portfolio.

Dziubinski: What about--there are investors who say, "Oh, I have to take my RMDs, and I don't need it." Nice problem to have, but ... So, can investors reinvest their RMDs?

Benz: Well, they can. So, you can reinvest in an IRA or even a Roth IRA. The key there, though, is in order to do that, you need to have earned income. And so, for a lot of 72-year-olds, they don't have earned income. Their income is either coming from Social Security or coming from their portfolio. But if you do have earned income, or your spouse has earned income, indeed, you can invest in that IRA. For a lot of people, from a practical standpoint to the extent that they have RMDs that exceed their needs, they can and should use a taxable brokerage account to reinvest the proceeds. I think that that can be a really nice strategy. And the other thing to keep in mind is that you can maintain your asset allocation with those new investments. So, say, you pull your RMD, but your asset allocation was just perfect at the time that you did that, well go ahead and take those unneeded RMDs and put it to the holding, put it to the type of holding that you just sold out of. So, you can retain balance in your accounts as you go about reinvesting those distributions.

Dziubinski: And then, what about the tax implications of RMDs? Is there really anything an investor can do about that?

Benz: Well, one of the big things you can do is that you can do what's called a qualified charitable distribution. So, this means that you are letting the charity or charities of your choice work with your IRA provider. And so, you're making a contribution to the charity or charities of up to $100,000 of your IRA. And the nice thing about that QCD, qualified charitable distribution, is that the amount that you do send to charity does not affect your income. And so, it's a really nice tax-saving strategy for the charitably inclined. I would say, if you're making any charitable contributions whatsoever and you're also subject to RMDs, take advantage of this QCD because it's a nice tax-saving measure. For the rest of people who have RMDs that they love to hate, the best way to reduce the tax bill on your RMDs is to do some strategy prior to RMDs commencing. And so, that might mean some conversions, perhaps a series of conversions in the early years of retirement before the RMDs kick in. That can be a terrifically effective strategy. So, if you're in that pre-RMD zone and you're retired or getting close to retirement, get some advice from a financial advisor or a tax advisor about steps you might take to potentially lessen the RMDs down the line.

Dziubinski: Well, Christine, thanks for your time today and giving us some ideas of things to think about during RMD season. We appreciate it.

Benz: Thank you so much, Susan.

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