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Why 70 Is the Pivotal Age for Retirement Planning

For retirees, everything changes when they must begin tapping their tax-deferred retirement accounts, says retirement expert Ed Slott.

Why 70 Is the Pivotal Age for Retirement Planning

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The first baby boomer turned 70 in early 2016. Joining me to discuss why age 70 is such a pivotal age for retirement planning is retirement expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Great to be back here live in Chicago.

Benz: It's great to have you here in the studio. Let's talk about age 70. A lot of people focus on age 65. That's maybe the year when they plan to retire, but a lot of important financial-planning considerations hinge around age 70. Let's talk about what changes for retirees at that age.

Slott: Well, everything changes because of the tax code. As most people know, that's the change part where you move away from accumulating money. Remember, you spend 30, 40, or 50 years working, saving, and investing in an IRA or a 401(k), and the money in these tax-deferred accounts hasn't been taxed yet. But it can't sit there forever. So, the government, years ago, decided, "Let's make it age 70 1/2" for some crazy reason--and nobody knows why. That's the date when they finally tell people, "We're sick and tired of waiting for you to drop dead--we want our money back."

Now, you have to go in a different direction. Instead of saving and saving and saving, now they want you to start taking this money out--whether you need it or not. The government is going to force you to take that money out, pay tax on it, increase your tax rate, increase your liability--even if you don't need the money. And you have to do this for the rest of your life or until your IRA or 401(k) runs out. They're called required minimum distributions.

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Benz: So, you are saying you're on your own when you hit age 70 1/2 and you're subject to RMDs. For a lot of folks in retirement, it's different for them versus people who will get pensions.

Slott: What's that word--pensions? Oh, right. They still have those. (Laughs.)

Benz: Unfamiliar these days, but some people still have them.

Slott: Most people don't have them. So, now these people who were in 401(k)s--maybe they rolled it over to an IRA--while they were working, it was kind of taken care of for them. It was on automatic pilot. It shouldn't be that way, as you know, but that's really the way it is. Then, they say, "Goodbye, good luck--here is your money." Now at 70 1/2, they have the risk and responsibility of investing, taking the money out, being aware of these tax rules--which are very complex when it comes to taking the money out. For example, it's a 50% penalty for missing a required minimum distribution; that's a pretty serious penalty. And if you have several accounts, you have to be careful: Do you take from the 401(k)? What if you have IRAs or maybe a 403(b)? So, it can get complicated for people.

Benz: Doing the right calculation. In terms of the missed RMDs, do you have an ability to wiggle out of that if you can prove that it was not an intentional oversight on your part? What are the rules there?

Slott: Absolutely. It's one of the easiest penalties to get out of. It happens quite a bit, actually. People are older. I've seen situations where people have come to me and said, "I'm 78--what did I have to do at 78?"

Benz: They haven't taken money out.

Slott: For eight years. It happens. And sometimes it's financial-advisor error; sometimes they're just confused--maybe they have medical issues. The key is taking immediate corrective action. As soon as you find you've missed or you're short because you missed a calculation, make up the missed distribution immediately, and then you file Form 5329--it's a tax form. You write down that you missed the required distribution for a medical reason, financial-advisor error, bank error--whatever the reason is--and you write "RC" on the line. It stands for "reasonable cause," and they will probably waive the penalty. In fact, they will almost always--they being the IRS--waive that penalty. But you have to file the form and ask them to waive the penalty.

Benz: So, you mentioned that there are a lot of tax issues associated with IRA distributions and RMDs. I know a lot of our Morningstar.com readers and users love to hate their RMDs. Let's talk about some of the tax implications. Your distributions are taxed at your ordinary income tax rate, but there are some ripple tax effects as well.

Slott: They are known as "stealth taxes"--taxes that increase under the radar. They go higher because your income is higher. So, when you take a required minimum distribution, it increases your income. When that happens, anything that's based on your level of income also increases. And it goes two ways. For example, other items of income could be pushed into a higher bracket, but the stealth taxes kick in when good things on your tax return--deductions, exemptions, credits--get phased out as your income increases. So, when you lose, say, medical deductions because your income went higher, in effect, you are paying a higher tax. So, that's how you get hit under the radar. And remember, this is income most people didn't want in the first place, but they're forced to take it out after 70 1/2. So, as you said, it has a ripple effect. It hits other issues that increase your tax bill. It doesn't only [affect the taxes on the required amount you're taking out, it can also increase the size of your distribution].

Benz: And estimated taxes are another consideration for people who have been used to having their taxes withheld. This is a different ball game.

Slott: Right. Now you have to go on estimated taxes. What I tell people is if the only reason you're paying estimated taxes is because of the required minimum distribution, then have the tax withheld from the distribution. Nice and easy. That way, you don't have to worry about making quarterly estimates and forgetting or missing a due date and having a late penalty. This way, if it's taken out from withholding, it's considered timely paid. No matter if you took your distribution Dec. 30 and you took withholding, that's considered evenly paid throughout the year. That's probably the cleaner way to do it. Have the tax that you estimate you'll owe withheld--whether it's just federal or federal and state. Have it withheld from the IRA distribution. You have to pay it anyway, so that's the cleanest way.

Benz: Should I use my previous year's tax return to inform the rate at which I do the withholding?

Slott: Well, you can do that the first year, if you didn't have a required distribution. But once you're into the required distributions, you more or less know how much it would be each year. Most people's income, at that point, doesn't change that much from year to year--although, as you get older, the rub gets more because your life expectancy gets shorter. You're required to take out a little more each year. I've had clients tell me, "I have higher income now than when I was working--what's going on with this thing? It's going up and up, and I'm not even working."

Benz: It's a high-class problem. That's a question I have for you, Ed. A lot of our Morningstar.com users tell us that they have these unneeded RMDs. They are taking this money out, and they're not sure how to reinvest it--whether they can get it back into an IRA. Let's address that question. What should you do with money that you want to keep investing but you can no longer have within the confines of a traditional IRA?

Slott: You're right. There are a lot of people in that situation. I tell them to start planning ahead of 70 1/2. Once you hit 70 1/2, the first dollars out are deemed the required minimum distribution. You have to take those dollars. They can't go back into an IRA. That's a mistake some people make; they say, "Well, I'm paying the tax--now I'll just put it back in." No, you can't. A required minimum distribution can never be rolled back into an IRA. So, I tell people to start planning in their 60s--right after 59 1/2. I call that the "sweet spot," because for those 10 years before 59 1/2, if you touch your IRA, you have a 10% penalty. At 70 1/2, you have to start taking out. But during the sweet spot in the 60s, there are no rules. This is the time to maybe start pulling some of that money out. Converting to a Roth IRA is an option. The benefit there is, yes, you have to pay tax upfront, but you can do it systematically over time so that by the time you hit 70 1/2 maybe your IRA has gone down substantially. And if it's in a Roth IRA, it's doing better. It's growing tax-free. One of the big benefits for the Roth IRA is that there are no lifetime required minimum distributions. So, that's a good antidote to the problem--start planning ahead of time.

Benz: How about if you haven't planned ahead, though, and you do have RMDs that you don't need but you want to keep invested? Is your only choice a taxable account of some kind?

Slott: A taxable account. But here's what you could do: Like I said, the first dollars out must satisfy the required minimum distribution, but after that you could take more out if you wish, and then convert that to a Roth IRA. You can always take more than the required amount. The required amount is just a minimum. You can't convert the required amount; that must come out. But you could use the money--once you take the required amount--to pay the tax on converting more of that money systematically over time, if you don't want to really hit a lot in one year, and over time you can get more into a Roth. Now, at that point, in your 70s, you're probably more doing a Roth conversion for your children and grandchildren than for yourself.

Benz: And here's where a good tax advisor or a good tax-savvy financial advisor can really help you make good decisions.

Slott: You could even put it into a life-insurance policy. The key is to take taxable money and get it into tax-free territory as a hedge against future higher taxes.

Benz: Let's discuss the qualified charitable distribution.

Slott: That's a good one.

Benz: This is something that was made permanent at the end of 2015.

Slott: Yes, for the first time.

Benz: We had all been waiting till the end of every year, but now we'll have some clarity going forward. Let's talk about what that is and why it can be something pretty neat for someone who is charitably inclined and has to take IRA distributions.

Slott: As somebody who does tax returns--according to me, anyway--100% of my clients are charitably inclined. When you ask if a person made gifts to charity, everyone gives. So, under that theory, most people give something. So, after 70 1/2, if you're going to give anyway, you should be giving IRA money because that money will be taxed if you take it out. If you do the qualified charitable distribution--the QCD, it's called--it's only available for IRA owners and IRA beneficiaries who are 70 1/2 or older. But the benefit, there, is if you're going to give to charity, give the taxable money--give the bad money. Don't give already-taxed money like most people do. It has to be a direct transfer from the IRA to the charity, and it satisfies or counts toward the required minimum distribution. And you can go way up to $100,000 a year.

So, if your required minimum amount is, say, $10,000 and you want to give $2,000 to charity, the first $2,000 you transfer out as a qualified distribution direct to the charity, and that comes off of the amount you have to take for your required minimum amount. If you did the whole $10,000, then the whole $10,000 wouldn't even go on your tax return. So, it reduces your overall rate. It's a much more tax-efficient way of giving to charity. In other words, if you are going to give to charity, this will cost you less.

Benz: Less than taking aftertax money and doing a deduction?

Slott: Or taking money out of an IRA, including it in your income, and then taking a charitable deduction that could be limited--or maybe you don't even itemize and don't get to take a charitable deduction.

Benz: So, beyond RMDs, let's get back to people who are turning age 70 this year or are past age 70. Regarding the Social Security tie-in, you say that there is no benefit to waiting beyond age 70.

Slott: I think people should know this, but I guess it pays to say it again. At 70, you can't get any more. If you've been holding off, don't forget to file for Social Security. Now you're at the most you can ever get; it can't go up any more. So, at least start taking your Social Security.

Benz: Another thing you say that folks should be thinking about--even older retirees--is the benefit of continuing to work at least somewhat in retirement.

Slott: It's a huge benefit for several reasons. Number one: You could put more money in. Now, with an IRA, the rules are tricky. IRAs and Roth IRAs work opposite for some crazy reason in tax law. For example, IRAs have age restrictions; Roths don't. Roths have income restrictions; traditional IRAs don't. So, you can't contribute any more to a traditional IRA after 70 1/2, but you can contribute to a Roth. So, if you keep working, you are earning more and you need to pull less out--although you have a minimum you must pull out. But if you're using other funds and Social Security, you don't have to pull out as much. The Social Security you get and the required minimums are set amounts; but the benefit is that you're saving more money, you can put money into a Roth if you're under the income limits, and your money will last longer. Generally, it is a great idea to keep working--if you can.

Benz: Ed, lots of great tips here for folks who are age 70 or even beyond. Thank you so much for being here.

Slott: Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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