Tips for Taking RMDs

RMDs, or required minimum distributions, are the mandatory taxable payouts that investors must take from their traditional IRA and 401(k) plans after turning age 70 1/2.

For many retiree households, the rules relating to required minimum distributions aren't all that important; they're actively tapping their IRAs or 401(k)s for living expenses, so they end up taking out more than the minimum during each year. But for retirees with other sources of income besides their IRAs and 401(k)s, RMDs can be a nuisance, giving them little control over their income and jacking up their tax bills. What's worse, missing an RMD can lead to costly penalties.

We recently asked our readers for some RMD strategies, lessons, and tips for those who are newer to taking RMDs or might be navigating the distributions for the first time.

In some readers' opinions (such as bubbygator), when it comes to RMDs, it's more a matter of technique than strategy: "The government determines the amounts, and forces the RMD ... all you can do is choose the timing during the year to make the withdrawal, and which investments to sell ... then what to do with the cash."

But other readers mentioned that they did think about RMDs strategically. Here are some excerpts from their responses. To read the entire thread and weigh in yourself, please click here.

Using the Bucket Approach Some readers noted that in advance of taking RMDs, they have tilted their portfolios to more liquid or income-producing assets, which then allow them to avoid selling stocks or mutual funds to meet the RMD requirement. As Morningstar director of personal finance Christine Benz points out in her article "7 Tips for RMD Season", if you're using the bucket system for retirement-portfolio planning, you can tie RMDs to your buckets in a couple of ways. Because it's a good idea to refill your cash bucket throughout the year, you can have income distributions from your IRA holdings sent directly into your cash bucket as they're paid out--those distributions may then fully or partially satisfy your RMDs.

"My strategy is to follow the bucket system with money in cash, bonds, and mutual funds. I plan to roll over my 401(k) into Vanguard or a similar fund company and also my traditional IRAs. This way all retirement money is in one place. I plan to instruct the fund company to move the RMD from the cash bucket to my checking account," said Ashvij.

"It seems to me that, even if one doesn't need them as spending money and takes a total-return approach to one's assets on the whole, an account requiring, or about to require, RMD withdrawals should be invested for income," agreed Bacholyte. "A bucket approach, as described by others above, makes a lot of sense, giving one time in advance to redeem shares at the best opportunity."

Rebalancing and Optimizing Your Portfolio While the concept of taking RMDs from the cash bucket seems straightforward enough, reader retired at 48 points out some potential challenges with this approach--mainly, establishing a plan for replenishing that cash bucket. The conundrum here, as this reader sees it, is that if you take the income from that bucket but don't replenish it, your portfolio becomes "riskier."

As Christine Benz wrote in a recent article, before you actually pull the trigger on your RMDs, conduct a thorough year-end portfolio review, taking stock of your asset allocation and the fundamentals of your holdings, including valuations. Holdings that look unattractive on a bottom-up basis or that are simply consuming too large a share of your portfolio should be at the top of your list when determining what to sell to meet RMDs. That can serve the dual goal of improving your portfolio and satisfying the IRS' requirements, Benz says.

As reader Retired at 48 points out, continually canvassing one's portfolio to find "good candidates to sell" can be a good tack, because strategically selling at more opportune times can help one avoid having to sell at disadvantageous times. "In some years, by doing these strategic moves, you could have the next year's spending bucket all full, or even overloaded, at the start of the new year. In other years, you may be waiting until December to replenish a bucket. This gives you a two-year spread in time, if necessary, such as navigating a bear market, where you need do nothing," said retired at 48.

In-Kind Distributions Meanwhile, some respondents, particularly those who do not need to use RMDs to cover current income needs and want to remain invested in certain securities, said the idea of in-kind distributions was appealing to them. In many cases, this involves moving securities from a retirement account into a taxable account or a Roth IRA. Though this strategy will not allow you to circumvent paying the income taxes on the RMD, it can help save some money on taxes. Here's how: You pay ordinary income taxes on the securities that come out of your IRA, and then when you move those same securities to a taxable account, any appreciation beyond today's prices will be taxed at the capital gains rate rather than at your ordinary income tax rate. (For more on this, see this article.)

Among the adherents to this strategy was EnvEng: "I will begin taking RMDs this December. My current plan is to do a transfer-in-kind of enough assets from my traditional IRA to my taxable account to meet the RMD. I don't need the RMD for living expenses. I reinvest all distributions as they come in, so all the accounts continue to grow."

Orygunduck provided some additional perspective on in-kind distributions: "Simply transferring securities in-kind whose values at least equal the RMD is a great way to meet the RMD, but it may do little to provide the required household cash flow ... whereas managing the IRA for cash flow from security sales, dividends, and interest may meet the RMD but do little to take advantage of tax-favored dividends and capital gains in the taxable account(s)," this reader said. "For the household using a total-return approach to generating required household income, there must be a balance struck between the RMD and taxable income generation such that the ideal relationship meets the RMD, the household cash flow requirement, and keeps taxes at a minimum. This combination will vary between retirement households depending on what percent of investables are in tax-deferred and taxable accounts, and household cash flow requirement."

Taking Distributions Proportionally Helps Keep Allocations Intact Finally, some readers, such as hondo and Chief K, prefer to have their fund company or brokerage calculate the RMD and withdraw the funds proportionally from the accounts; doing so allows them to keep their asset allocations intact, which could help limit the amount of rebalancing required.

For instance, hondo, who does not need to take the RMD for living expenses, said: "Each year on a set date ... the investment company automatically withdraws the RMD proportionally from each IRA fund we own and transfers the money to our bank account. We then reinvest the cash in our taxable funds. By having it done automatically, we will not miss the deadline, and by withdrawing the RMD proportionally from the IRA accounts, there is no need to rebalance the IRA accounts. The allocations will remain the same."

"I have fund companies (Vanguard and one other) take out the money once per year," said Chief K. "I have it taken proportionally from my assets with each fund company. At age 70, I figure I should have my asset allocation at each fund company pretty well settled."