A version of this article was published on Dec. 1, 2021.
Many retired Morningstar.com users find themselves with the high-class problem of resenting their required minimum distributions. Their RMDs force them to pull money out of their tax-deferred accounts, above and beyond what they need for living expenses, and trigger tax bills to boot. I've also heard retirees complain that the RMD tables force them into a more aggressive withdrawal rate than they're comfortable with. (Of course, you can always reinvest the money back into other accounts.)
But RMDs—like taxes—are inevitable. Not taking them isn't an option, since the penalty for missing an RMD is 50% of what you should have taken and didn't—plus the taxes that are due! Even though the penalty can be circumvented if you have a good reason (and file the proper paperwork), that's still a pretty big deterrent.
Yet taking an RMD doesn't have to be all negative. With a little lead time, you can use your RMDs to improve your portfolio's risk/reward profile. Rather than giving each of your holdings a haircut to raise the cash for the RMD, or automatically cutting back the most conservative positions, the starting point for approaching RMDs is to check up on your portfolio. Armed with knowledge of its problem spots, you can then concentrate your RMD-related sales in those areas you wanted to fix anyway. As long as you take the right RMD amount from your own IRAs, it doesn't matter which holding the money comes from. You can then use your RMD proceeds to achieve still other goals.
Here are the key steps to take to improve your portfolio at the same time you're meeting your obligations with the IRS.
Step 1: Determine Your RMD Amount
The starting point for strategic RMD-taking is to find the amount you're obligated to take out. All traditional IRAs (not Roth) are subject to RMDs; that includes SEP and Simple IRAs, as well as plain-vanilla traditional IRAs. Assets in company-retirement plans (including Roth 401(k)s) are also subject to RMDs, as are inherited IRAs.
To determine RMDs for 2022, find each account's market value at the end of 2021. Armed with that dollar amount, find the RMD table that corresponds with your situation. Most accountholders will use the Uniform Lifetime Table; a separate table applies to accountholders with spouses who are more than 10 years younger and who are sole beneficiaries.
But don't necessarily stop there. One aspect of RMDs that helps you be strategic is that you don't have to take an RMD from each account. For example, you can add your RMD amounts from all of the IRAs in your name (SEP, Simple, and traditional) and take a single withdrawal from just one of the accounts. RMDs from multiple 403(b) plans can also be consolidated in this fashion, as can RMDs from inherited IRAs.
Yet it's also important to bear in mind which RMDs can't be consolidated. If you have both an inherited IRA and a traditional IRA, you must take separate RMDs from each account. If you hold both a qualified company retirement plan and an IRA, you must take separate RMDs from each account. If you have multiple qualified plans and are subject to RMDs, you must fulfill your RMD obligations for each account rather than consolidate. It's also worth noting that spouses can't combine their RMDs and take the amount from just one of their IRAs. (Even though your finances may be combined, the accounts are in each of your names, not joint.)
Step 2: Survey Your Asset Allocation
Armed with your RMD amount(s), turn your attention to your portfolio. Start by getting an X-Ray view of your portfolio's asset allocation; compare that to your target allocations. If you identify imbalances, you may be able to address them, at least in part, with strategic pruning of appreciated holdings. For many investors who have been taking a hands-off approach to their portfolios, their equity holdings are apt to be enlarged relative to their targets. A portfolio that was 60% S&P 500 and 40% Bloomberg U.S. Aggregate Bond Index 10 years ago would still be about 80% equity today. (Stocks have slumped so far in 2022, but so have bonds.) And of course, U.S. stocks have dramatically outperformed foreign, though foreign stocks have performed decently in absolute terms. Because your portfolio's baseline asset allocation will be the main determinant of how it behaves, it makes sense to pull your RMDs from those asset classes that you'd like to cut back on. For many investors today who don't have cash on hand to pull their RMDs from, U.S. equities are a logical place to look.
Step 3: Identify Holdings to Trim
Once you've identified which asset classes you'd like to trim, scout around for specific holdings to cut. Assessing your portfolio's Morningstar Style Box and sector exposure is a good next step when identifying holdings to prune; you can use your sales to correct any big imbalances. While value stocks have enjoyed a resurgence thus far in 2022, growth stocks have gained substantially more than value names over longer-term trailing periods. This is also an ideal time to scout around for holdings that are problematic—or at least less than ideal—from a bottom-up standpoint. In other words, your ideal positions to prune would be a high-returning U.S. growth fund that has recently experienced a management change or pushed through an expense-ratio hike.
Step 4: Decide How to Deploy the Assets
Deciding where you'll go for RMDs is the biggest hurdle. Before you take action, however, get a plan for what you'll do with the money. Will you use it for current spending or to help refill your cash bucket to supply next year's living expenses? Or will you reinvest the money into your long-term accounts? Reinvestment can be a good strategy if your RMD amount will take you above your planned withdrawal rate for this year. A taxable account will be the most likely option for RMD-subject investors. Alternatively, if you or your spouse has enough earned income to cover the contribution amount, you can steer the cash into an IRA. (A Roth will tend to make more sense than traditional for RMD-subject investors because RMDs don't apply to Roth assets.)
Finally, if you're charitably inclined, be sure to consider a qualified charitable distribution. The QCD enables you to steer up to $100,000 from your IRA's RMD to the charity of your choice. The beauty of that strategy is that the RMD won't bump up your taxable income at all. Moreover, fewer and fewer taxpayers are apt to be able to get more bang from itemizing their deductions, including charitable contributions, than they will from taking the standard deduction. That means that the QCD is a way to be charitable and reduce taxes. Just be sure to decide if you want to do the QCD before pulling the proceeds from the IRA, and check with your IRA custodian to make sure you're following the right steps. You'll likely need your IRA custodian to work directly with your charity to conduct the transfer; alternatively, if you have check-writing privileges with your IRA custodian, you may be able to write the check.
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