Required Minimum Distributions
David Scranton: Welcome back to the income generation the show where we share that valuable information for that critical period in life when you’re either in or approaching retirement. I’m David Scranton your host, and I’m glad you’re joining us and I’m going to urge you, right off the bat to pay very, very close attention to today’s show. Maybe even call a friend or encourage them to watch and here’s why, we’re going to be talking today about required minimum distributions, or RMD’s for short, and this is one of those subjects that may not sound very exciting, but the more you know about it, the more likely are to spare yourself a lot of frustration and save yourself a lot of money, by watching today’s show, oh and by the way, it’s also a subject that you’re probably going to have to deal with at some point and the earlier you start to prepare, the better off you are. There’s really no avoiding it, if you have retirement savings, then once you’re past the age of seventy and a half, you’ll have to take RMD’ and you have to pay taxes on those required minimum distributions and it’s crucially important that you take them correctly, why? The penalty for not taking sufficient required minimum distributions, each year after age seventy-and-a half is a whopping 50 percent. In fact, avoiding costly missed steps like that is one of the things you’re going to learn about on today’s show, but that’s just the tip of the iceberg why? Although there may be no avoiding required minimum distributions, there are ways of making sure that your own required minimum distributions, truly are the minimum, even more importantly, there are ways of making sure that your RMDs are satisfied with no unnecessary burden or risk to your overall savings or retirement plan, you’ll learn a lot more about that later in the show, but first, let’s cover some of the basics that you need to know about this subject. Why does the government force you to take these required minimum distributions starting at age seventy-and-a-half? The simple answer is that the government loves what I like to refer to as, use specific plans, for example, 529 college tuition plans are extremely tax-efficient if they’re used for college education for your children or for your grandchildren, but they’re also extremely tax inefficient if used for anything else, such as retirement. Similarly, retirement accounts, like Forward’s, For three Bs and 57 plans, which I’ll refer to doing the show, hereafter as retirement plans. These are used specifically for retirement. In fact, the government offers these plans to encourage people to save for retirement, therefore if the money inside these plans is actually used for retirement, it’s taxed in a very friendly manner, meaning that your taxes on it, can be deferred until you reach the age in which your RMD’s kick in, however, if the money is used for anything else, the IRS is not so friendly, for example, if you would draw any of your money from an IRA or any of these retirement plans before age 59-and-a-half as a general rule, you may be subject to an additional tax penalty of 10%, simply put, because IRA’S and retirement plans are designed for retirement income. The government wants to make sure that you use them for retirement, at the same time, though the government does ultimately want to get its tax money on these accounts, and that’s the very reason that required minimum distributions are mandatory after age seventy-and-a half with longevity rates longer than ever before. The IRS simply does not want to risk waiting until after your death, to collect taxes because God forbid, you might actually live to be 100 years old. One of the frustrations I hear a lot about RMD’s is that many people defer taxes thinking that they’re going to be in a lower tax bracket once they retire, but as most of our retired viewers could probably attest, they’re really not in a lower tax bracket, in many occasions in fact, many are now taking money out of these IRA’S and various retirement plans and actually paying taxes in a higher tax bracket, that’s just one of many potential issues related to the complex process of calculating your RMDs. You’ll learn a lot more about this later, in the show, but here are just a few things that you need to know to get started and understanding your RMDs. Before we go to our next segment, the amount of your required minimum distribution is determined primarily by a table in an IRS publication called publication I-90, this gives you what we call your government assumed life expectancy for each age at age 70 or beyond. Now, to calculate your required minimum distributions you simply have to take the balance of your IRA’S on December 31st of the previous year, and again, IRA’S means all types of retirement plans and divide it by this assumed life expectancy factor. So at age seventy-and-a-half your assumed life expectancy is actually 27 years, meaning that your required minimum distribution becomes equal to about 3.6 percent of your IRA balance. As you can see by the table, it then increases every year as your assumed life expectancy decreases every year, before you reach age 80 your assumed life expectancy is less than 20 years which means your required minimum distributions exceed five percent, and by time you’re in your mid-80s, they exceed six percent of your retirement plan balance, by the way, you might just notice from these charts that these government assumed life expectancies are actually much longer than your statistical life expectancy, for example, at age 70, the average life expected is probably not 27 years, why? The government assumes that whether you’re single or whether you’re married it assumes that you actually are married to a spouse that’s 10 years younger than you and by that rationale, your joint life expectancy at age 70 is actually 27 years, so you’re actually granted a longer assumed life expectancy that allows you to take a lower required minimum distribution and therefore pay less tax. What if your spouse is more than ten years younger? Well then things get a bit more complicated as we’ll talk about later in the show. Now you might also be wondering, how do I potentially end up paying more marginal tax, higher taxes because of RMDs? Again, we’ll talk about that more and all the relevant details surrounding that later in the show, and also steps that you could take to try to minimize the tax burden of your RMD’s. The question we’re going to focus on first however, is this, and it might be the single most important thing that you need to know about your required minimum distributions and it’s a big part of the reason why I said that even if you’re not close to age 70, you still want to focus on this today and here’s the question, “Is your asset allocation ready and prepared to generate those required minimum distributions?” Again, even if you’re sixty years old and feel like you have a long time to think about it, you’re going to want to stay tuned to pay close attention to this because it’s probably the single most important issue related to the topic of required minimum distributions. We’ll be right back after the break, to talk about this. So the question becomes, “Is your retirement allocation right for taking RMD and why is that so important? Allow me to answer those one at a time, first, having the proper asset allocation for RMDs means having a strategy based upon something that your mom and dad probably told you, the day you opened your first savings account, spend your interest and protect your principle more specifically, it means having your retirement accounts set up that you can earn enough interest in dividends to satisfy your required minimum distributions, without having to touch your principle. How much is enough? Well, as explained, at age seventy-and-a-half your required minimum distribution is 3.6 percent of your retirement account balance. It then increases every year as you get older and your life expected to get shorter surpassing five percent, by the time you reach age 80 and so on. So as a general rule, your target should be an asset allocation that generates at least a 4 percent or preferably a 5 percent interest or dividend rate net fees, without that, you may end up having to take your required minimum distributions from principle and that brings me to my second point, why having the right allocation for your arms is so vitally important, In a nutshell your mom and dad were absolutely right and financial strategy that requires you to draw money from your principle even occasionally is very dangerous, especially when you’re in your 60s or 70s. It’s true as a general rule, but it’s especially true after you’ve retired. Think about it, with average life expectancies today longer than ever before, people typically need to plan for a thirty-year retirement, that makes spending any principle, a very slippery slope when you’re in your 60s or early 70s. Think of it like a 30-year mortgage and I know we’ve talked about this before, on the show, but it keeps repeating, at the beginning of a 30-year mortgage are you paying that any principle to speak of? Of course, not at the beginning, you’re paying primarily interest and just a little bit of principle, but with each passing year, you pay a little less interest and a little more principle, as the balance gets paid down somehow, by the time 30 years goes by, your mortgage is completely paid off. Now think about that in reverse. Think about a pool of money, let’s say one million dollars in retirement accounts generating three per cent a year of interest or dividends, now tack on a 1 percent management fee and you’re only getting 20,000 dollars a year from that million dollar investment account. If you take just a little bit of principle just, a little more than 20,000 dollars each year, that sum will be depleted within 30 years, much like that mortgage is somehow paid off after 30 years. You see, the problem today, of course, is that it’s harder and harder than ever before, to generate the kind of interest you need to satisfy these RMDs without touching principle, you don’t need me to tell you that if you are invested in bank for example, you’re probably not earning 4 percent or anywhere near it. If you’re in high quality bond mutual funds you also are most likely still shy of that 4 percent after you factor in management fees, and what about the stock market? While the numbers are pretty similar, If you do just a little research on sites like dividend dot com you’ll see that a competitive dividend in the stock or stock mutual fund today is on average around 3 percent, but again, if you’re paying a 1 percent management fee then you’re netting only two percent so where will the other two percent come from to satisfy a required minimum distributions? Well, again, the only other choice is to take it from your principle and that’s even a slippery slope when it comes to the stock market, why? If you’re selling shares of stocks or stock mutual funds every single year to satisfy required minimum distributions, then you’re in danger of falling into a trap, which I often refer to on the show as reverse dollar cost averaging, it’s basically cannibalizing your mutual fund or your stock portfolio and it’s one of the most common and one of the most costly mistakes that retirees can make with their money. Now I know that most people are familiar with the concept of traditional dollar cost averaging, this occurs when you’re younger and you’re saving on a regular basis for retirement and things such as a 401K, you were dollar cost averaging back then because you’re putting money away each and every month, what that means is that you are getting your average cost or your average purchase price of these mutual funds in the 401K for example down you are lowering the purchase price and remember that investing is simple but not easy, the simple part is to buy low and sell high and dollar cost averaging is often touted as a strategy that helps you buy low. Let’s take an example, if you set out to buy one hundred dollars per month of a mutual fund and the first month, the fund was worth ten dollars a share, then you bought of course ten shares, because ten times ten is 100. So, let’s say, for example, that the unthinkable thing happens, and the second month, the fund drops by half, it drops all the way down from ten dollars a share to five dollars a share, but you have the internal fortitude to stick with your plan, now in the second month at 5 dollars a share your 100 dollars now, buys 20 shares. So, the question I have for you is really simple, if you were to stop after two months what is your average cost per share? Now, if you’re talking to the television and you said 7 dollars and 50 cents you’re not alone because that seems to be the intuitive answer, but the real answer is at average cost per share with six dollars and sixty-six cents because you bought twice as many shares at five dollars and only half as many shares at 10 dollars, so it helped you buy low, in fact, dollar cost averaging helps you get your average purchase price or average costs, down, which is the first half of the equation of buy low and sell high. The problem now however as you approach age seventy-and-a-half, is that you’re at a point where you’re no longer saving on a monthly basis in fact you’re doing quite the opposite, you’re at a point where you’re soon going to have to start taking these required minimum distributions if you haven’t already from your IRA’S, in various retirement accounts on a regular basis, that means that if you aren’t generating enough interest or dividends to satisfy those RMDs you may have to liquidate principle, liquidate funds on a regular basis in other words, reverse dollar cost averaging. Now, the math here is exactly the same, only in reverse, because now, instead of buying more shares, when the market’s down you sold more shares when the market’s down courtesy of the IRS. So that means not pushing your purchase price down, instead it means you’re pushing your sales price down, which is the exact opposite of buying low and selling high, you’re selling low which is what you don’t want to do. Dollar cost averaging is one of those things that works great in one direction, but is horrible in the opposite direction, it’s kind of like toothpaste, toothpaste is great when you’re trying to get it out of the tube, but have you ever tried to put it back into the tube, it doesn’t work so well. So where as dollar cost averaging is a great strategy for young savers, reverse dollar cost averaging is one of the most cancerous financial strategies that you can embark upon during retirement. Now, the picture gets even worse if the market should take a major sustained plunge like the two we’ve had, since the turn of the century from 2000 to 2003, and again for 2007 and 2009 in each case, the market dropped by approximately 50 percent or more and took six and seven years to fully recover. If you’ve watched this show in the past, you know, I firmly believe that the market is overdue for another major down turn in the next couple of years. If you should get caught in one of these terrible down drafts as a retiree selling shares to satisfy these government forced required minimum distributions then it means that each and every year the market drops, you’ll have to sell more shares of your stock or mutual fund to get that government forced withdrawal, but here’s some good news, there are other options if you’ve watched the show before you know that I also firmly believe in the strategic value of investing for income, particularly for today’s generation of retirees or near retirees what we call the Income Generation that means financial strategies built around conservative, non-stock market alternatives that are specifically designed to generate income through interest in dividends and designed to protect your assets from major market downturns, this generates income that you can spend today if you need it, or re-invest for additional returns and portfolio growth. I call it growing your money, organically or growing it the old fashion way, or these existing dividends can be used to satisfy required minimal estimations, without having to worry about cannibalizing your principle. Well many people don’t realize that because it’s generally so difficult today to get a four-or five percent yield in the stock market or in stock mutual funds, for example, people don’t realize that by lowering your risk in these income generating instruments you actually can increase your yield. A lot of people believe that if you want to increase your interest or dividend yield you have to take more risk but it doesn’t necessarily work that way when you increase your risk you’re actually often times reducing your interest or dividends because you’re increasing your risk crossing your fingers and toes, hoping to get growth or capital appreciation, but we all know that growth is not assured, ironically, if you want to increase your interest and dividends, you actually can lower your risk, and that’s just one more reason why reducing your stock market exposure, and focusing on these strategies, designing to generate income to interest in dividends makes so much sense. Stay with us right after the break, we have a special surprise with a very special guest we will be right back. Welcome back, our guest today, was named the best source for IRA advice by the Wall Street Journal and also named America’s IRA expert by Mutual Fund magazine, he’s an author, speaker and television host our guest today, Ed Slot is known to financial advisors for his highly informative training programs, he is also known to consumers for his five books on retirement distribution planning, which include “Stay Rich for Life”, “Growing and Protecting Your Money in Turbulent Times”, he’s also hosted three public television specials aimed at helping investors minimize their tax burden and stressing the importance of working with a competent financial advisor. Please welcome today, Ed Slot. Ed good to have you on the show.
Ed: Great to be here, Thanks Dave.
David Scranton: Great, as you know, today our topic is required minimum distributions. So in your opinion, what are the three, not even three but what are the most important things that people need to remember about required minimum distributions?
Ed: Well, they have to remember that they’re coming. Once you turn 70-and-a-half, everything changes, your whole life, you’ve spent saving, building, investing, now you have to go the other way and start taking money out. So it’s a bit of a transition and some people, a lot of people I hear don’t even need the RMD money, it’s forced out, it’s kind of out of their control, so they have to take it, it adds income to their taxes, so it raises their taxes even though in most cases they don’t really need the money so it is kind of upsetting for many people who spent their whole life saving and now are being forced to take that money out and that’s just the taxes.
David Scranton: So if you can, just tell her viewers, what are some of the most common mistakes that they need to watch out for? regarding RMD’s.
Ed: You have to take account of all your retirement accounts so that includes IRA’S, simple IRA’S, you might have a 401k at a job, or you may have several or 403 B, so you have to take all the plans into account, but they all work differently, for example, for your IRA’S, you have to add the balances, you actually have to calculate the required amount from each account, but you can take the required amount from any combination of accounts, you can do the same thing with a 403-B, but you can’t mix and match, and that’s where the problems come in. In other words, you can’t satisfy a required IRA distribution by taking from your 401k that has to come from your 401K. If you have several 401K’S you can’t combine them, the RMD has to be taken from each one and you might have different beneficiaries on certain IRA’S or 401Ks so it can get confusing, probably a better course of action once you get past 70-and-a-half is trying to consolidate your account so you don’t have accounts everywhere because it can get overwhelming.
David Scranton: Now, what if somebody is still working at age 70-and-a -half then how does that affects their RMD’S differently?
Ed: Yeah, that’s a good question and that’s an area where we see lots of problems. There is a special exception as you just said, if you’re still working for a company that you don’t own, so it’s not for self-employed people, that’s one mistake. If you own more than five percent of the company, the exception does not apply to you, but let’s say you’re an employee at a company that you don’t own, if you’re still working there, you can delay that 70-and-a-half date until the year you retire, so if you retire at 80, it doesn’t start till 80, but the exception or the waiver you might call it, from RMD’S only applies to the 401k of the company, you’re still working for, it doesn’t apply to your IRA’S, or other plans, you may have. So from those accounts, let’s say your IRA, there is no still working exception, you still have to pull that money out, so the exception only applies to that company’s plan of the company you’re still working for.
David Scranton: So, if someone is still working to have a plan, but the plan accepts roll-over from other 401K’s in theory, someone could roll money into that active 401k and avoid RMDs until they retire, is that correct?
Ed: That’s true. If the 401k allows rollover in, they don’t have to. This is one, unusual area about the tax law, the tax law is rigid, in many respects but it happens to be liberal in this area. In other words, the rules can be much more rigid, they don’t have to allow everything, the IRA, tax rules or the IRS tax rules allow. So, what you just talked about even the still working exception, the plan doesn’t have to allow it just because the law allows it, so you have to know if your plan allows rollover in in the first place.
David Scranton: Right now what if you mentioned before that some people don’t even want this money, so what do you tell people they can do with these RMD’S if they’re forced to take them, but they don’t really want or need the money, what are their best options in your opinion?
Ed: Well, I tell you it’s a good problem when you don’t need money from your IRA and remember, the distributions you start off with are very small, the required amount ,so the first few years are under 4 percent, but you still have to take them, and you can’t do certain things with them. You know the number one question I get from financial advisors and it’s logical, but the tax law isn’t logical their question is well, my client is, say 72 taking required minimum distributions, they have to pay tax on that money, they’re paying tax on it anyway, so can, if they don’t need the money can they just convert it to a Roth IRA? The answer is no, absolutely not, even though it makes sense because the tax law says you cannot convert a required minimum distribution, that’s why, if you’re thinking conversion, you might want to think about that before you start at, before you turn 70-and-a-half, the first dollars out have to be the required amount those amounts can’t be converted to a Roth, you just have to take that money after you satisfy your required amount then you can convert other moneys, but then you’d have to take out more. So, what else can you do with that RMD If it’s not wanted? you can use it, once it’s out of the IRA, it’s regular money, you can use it for anything you want, you can bet on a horse if you want to, or if you really want to do a Roth conversion, you could use that money to pay the tax on converting other Ira funds that are eligible to be converted, or if you’re still working and you want to contribute to a Roth IRA, you can use that money not to roll it over, but to contribute to a Roth IRA. If you’re still working, now, that’s interesting because with Roth IRA you can continue to contribute after 70-and-a-half with traditional IRA’S, you can’t so there are some uses for the unwanted RMDs.
David Scranton: That’s great, I know you well enough to know that you’re conservative, so I know you really aren’t espousing betting it on a horse but I like the idea about using it for other money through a lot of the–
Ed: I’m just making a point, you can do anything you want with it once it’s out of the IRA it’s free money.
David Scranton: That’s great, Ed we need to take a quick break right now, stay with us when we come back, we’ll talk to Ed Slot a lot more about some of the mistakes that people make, particularly with beneficiary designations on IRA’S and retirement plans, and we’ll also talk about what to do If you make a mistake and subject yourself to the penalty, there might just be some ways to get out of it, we’ll be right back. Welcome back, we’re here today with America’s IRA expert Mr. Ed Slot who as a financial advisor is someone that I’ve known for many, many years, and Ed is, in the financial advisory world you are truly known as America’s IRA expert. So, I appreciate you being here today and-
Ed: Alright thanks.
David Scranton: We tease people a little bit up front about the fact that if you make a mistake with the RMDs, you do not take enough, there is a 50 percent five zero penalty, but I also know that you have a way that might, where somebody may not have to pay that penalty, if they make such a mistake.
Ed: That’s true.
David Scranton: You mind sharing with some of our viewers?
Ed: And it’s not a secret way you just have to know it. First of all, I don’t want to scare people. It is, do you say I say the same way as you by the way, I say five oh, 50 percent because people think maybe fifteen per cent of the amount you should have taken but didn’t. That’s a pretty steep penalty.
David Scranton: And that’s an addition to the tax.
Ed: Most people don’t pay the penalty and here’s why. Let’s say you’re just starting RMDs, you forgot, you were confused, you made the calculation wrong, maybe the advisor made a mistake, somebody at the bank made a mistake, you had medical issues. There are a whole bunch of reasons why this might be missed or the calculation is off and you didn’t take enough, all you have to do first thing you have to do as soon as you realize and it’s usually the next year, soon as you realize you missed out because if it was that year you could still make it up. So, I’m talking about when you realized sometimes after it’s a tax time that the prior year you didn’t take 5000 well that’s a twenty-five hundred penalty. What you do, as soon as you realize the mistake, you immediately take the misdistribution out right then, you can’t take it back in the other year cause that’s close, unless you had a time machine, so you can’t go back to that year, so you have to take it immediately. I suggest taking a separate stand-alone distribution like a make-up distribution, so you can trace it. That’s the one you missed and then take your regular one, then once you take what I call immediate corrective action, that’s what the IRS like to see, that once you caught it in good faith, you took that distribution, then you file Form 5329 or work with your account, no tax prepare, file form 5-3-2-9, fifty three, twenty nine and on there, there’s a line on the second page where you can say I missed the distribution, here’s the reason, you don’t have to give a big explanation. I had medical issues, I was confused. I made the wrong calculation and that’s all and you put, an R-C-computer programs will type that in the letters R-C stands for reasonable cause and you don’t have to pay the penalty years ago you did, you don’t, you just show zero and IRS in almost every case will wave that penalty, but you have to file the form to get the waiver.
David Scranton: Form 53 29 got it, and we also talked about it on the show.
Ed: Here is another fact about that form. If you don’t file the form the statue never begins to run. So let’s say you forgot about it for ten years, it doesn’t go away, that 50 percent penalty can be brewing plus interest and penalties. So yeah, have to file that form.
David Scranton: Ed really quick, in the 30 seconds or so we have left in can you share with our viewers, one most common mistake that you see with beneficiary designations on retirement money?
Ed: Well, losing them, not keeping them up to date every time, this is what you have to think about. You have an IRA and the beneficiary determines how soon it will be taxed, how much it will be taxed, and every time you have what I call a life event, a birth, a death, a marriage, a divorce, you add a new grandchild to change in the tax law, update that beneficiary form, name primary beneficiaries and contingent beneficiaries that goes for every IRA you have, every Roth IRA, every 401k or company plan and keep those where people can find it if they can’t find that it’s the same thing as if you never had it.
David Scranton: And also make sure you don’t have a trust in most cases is beneficiary of the IRA.
Ed: Well, you know that’s what you need, advice. There are reasons to name a trust. You have a large IRA, you have a beneficiary that’s a minor, disabled and incompetent un-sophisticated, afraid they’re going to spend it all, they’re spendthrifts. There are reasons to name a trust mostly, when you don’t trust they should have called it a don’t trust because if you do that, you would need a trust.
David Scranton: That’s great, a don’t trust, I love it, and thanks so much, we’re out of time, time flies when you’re having fun. I appreciate you being here today and I look forward to the next time and for our viewers stay with us, when we come back Morgan and I will talk more about required minimum distributions and some of the things that you need to watch out for and so the things that you can pay attention to, we’ll be right back after the break.
Morgan: So, David, the beginning of the show, you talked a little bit about how to calculate your RMD’S using this table which we are going to show you again, and it can also be found in the IRS Publication 590
David Scranton: That’s right, the good old IRS publication 590. It’s really simple in general terms, because what you do is you take your retirement plan balances as of December 31st of the previous year, of course you have to do this every year, starting at age seventy-and-a-half, and every year thereafter take the balances of the previous year and divide it by whichever life expectancy factor is on the appropriate line for your current age, and that gives you the required minimum distribution for that year. Now, of course, in theory that means it’s simple.
Morgan: But it’s really not quite that simple, in practice, yes?
David Scranton: No it’s not. The first thing that we have to be concerned about is a differential. Remember the basic table for publication 590 says there’s a ten-year difference between you and your spouse. So even if you’re not married, it assumes you have a spouse that’s ten years younger than you.
David Scranton: If you have a spouse that’s more than ten years younger then you have to go to a separate part of that table where you look at your age, his age, and then you get the longer life expectancy which allows you to take a smaller required minimum distribution.
Morgan: So let’s say, for example, you and I were married, we would have to use that table, of course?
David Scranton: Cute, really, really cute. She may have some of you fooled because we all know she looks about 20 years younger than me, but the reality of it is, sorry, Morgan, I know you’re dirty little secret and no we’re going to be using the basic table because we are within ten years of each other. So there, I just outted you on national television.
Morgan: Why does that make a difference? They assume, I guess based between the two of you, because one is so much younger as an average, you will both be longer overall?
David Scranton: Yes, it should be in a show. They want to make sure they use it for retirement income, but they don’t want you to outlive your retirement income. So, if one spouse is 70, and the other one’s age, 40, well then if you use age 70 cables that person would certainly run out before the 40-year-old gets average life expectancy. So, it’s just a fairer way of doing it.
Morgan: Makes sense. So isn’t it true that certain kinds of annuities have to be separated from your basic calculation and that the RMDs on those annuities have to be calculated differently?
David Scranton: Well, now you’re getting to where the rubber really meets the road. So people often times will listen to me and explain required minimum distributions and say well, this is easy, I think my balance as of December 31st, the previous here, I divide it by my life expectancy factor and boom that’s the result, the first exception to that rule, which of course as you can imagine, the IRS never makes anything quite that simple. The first exception in these things called annuities and there are certain types of annuities that actually stand to increase the amount of your required minimum distribution and therefore increase the amount of taxes to do and Morgan these are typically annuities that are called immediate annuities or annuities that are annuitized, which is another word for an immediate annuity, where it gets tricky though, is that I know some of our viewers may have annuities that have something on called a rider, which in order to get some guaranteed benefit at some point down the road they may have to convert that into these types of annuities and again, that serves to actually increase the RMD and therefore increase the amount of income taxes better, do and that is the first area where the rules really start to get more complicated.
Morgan: Okay and just to further complicate things, I also understand that 401k’s or other qualified plans that you haven’t rolled over yet also have to be calculated separately and differently from your other IRA’S is that true?
David Scranton: That is true, and that’s why one of the reasons most people typically, before they turn seventy-and-a-half, they roll over their 401k’s, or 4 three B’s or four 57 for compliments into an IRA, makes the calculation easier but if you have not rolled your 401k or your 4 three B’s or your four 57 to an IRA, yet, then you have to calculate those separately, so you have to calculate the amount of RMD’s attributable to your IRA’S, and take that money from your IRA, and then go to these other plans and calculate the amount of RMD attributable to each of those and take it from each of those plans separately. So it does serve to complicate things, which again is why most people by time they turn seventy-and-a-half, have indeed rolled over their retirement moneys into IRA.
Morgan: Okay, well, we have to take a break right now, but don’t go anywhere because when we come back, we’re going to talk about the tax implications of required minimum distributions. Welcome back to the Income Generation, I’m talking with David J Scranton, so David once I calculate my RMD’s, how do I determine how much tax I owe?
David Scranton: Well, a lot of people get confused by this. Do you know when you go to your tax accountant, and they give you a report after that where they say, Well the taxes you owe this year were 27 point 1-5 percent of your income seems some odd number like that.
David Scranton: Well, here’s the interesting thing. There is no such thing as a 27 point 1-5 percent bracket the brackets are 10 percent-15 percent 25-28, and then so on, they keep going from there. So the real concept to understand and be able to calculate how much tax you owe because or the minimum tax distribution lies in a concept which we call marginal tax bracket so marginal tax bracket is the highest tax bracket in which your current income exists so if you’ve already gone through a 10 percent and 15 percent and 25 percent and now you’re in the 28 percent bracket, you have to worry about that 28 percent number, because you’ve already maxed out the other brackets and every additional dollar that you’re going to have to pay taxes on due to required minimum distribution is actually taxed at that top level, it’s added on to your income from all those other sources, so that’s importance of the marginal tax bracket not your average tax bracket.
Morgan: And speaking of taxes, will the income from my RMDs cause my social security to be taxed heavily?
David Scranton: Well, it very well could. Do you remember wasn’t long ago we did the Social Security show—
David Scranton: And we talked about how social security can be taxed and how they do that, of course, is they take your total income and they add to that half of your social security benefits, or as much as maybe 85 percent of your benefits, they add to that your tax-free municipal bond income and they come up with this thing called a provisional income and provisional income is actually, something that’s spelled out right in the IRS code it’s a real word.
David Scranton: And then they help use that to calculate how much of your social security is taxed, so it’s actually possible that, for a dollar of required minimum distributions you might actually have to claim an extra dollar and a half as taxable income.
David Scranton: Because an extra dollar is taxed but then an extra 50 cents off social security can be tacked on top of that. So, it’s often times a rude eye awakening experience for people because they find that their top tax bracket their marginal bracket, in essence, could be as high as the richest person in the world and even though they’re making less than average retirement income because of that, extra taxes on their social security.
Morgan: And is there anything you can do to set it or it’s just that’s the way it is, that’s the law?
David Scranton: There are some things you can do to offset it, and that’s where, where a lot of people talk to us about a one-on-one consultation, where as a financial advisor, people come to see me or their current financial advisor to say, Okay what can I do strategically to reduce taxes? Everybody’s situation is totally different, but some of it starts and part of the reason that we encourage people your age to be watching the show, even though you’re not seventy-and-a-half-years-old yet, is that you have to make a choice. How much of your money do you really want to put in the pre-tax, retirement, instruments versus how much you want to put after tax because of things like Roth IRA’S, or other things, because it’s great to save tax your entire lifetime, but you can create a tax time bomb that’s going to hurt you down the road. So that’s one of the keys, is to do planning in advance to prevent all of this from happening. Once you’ve gotten to that point, then it really becomes tax planning one-on-one based upon your particular tax situation.
Morgan: And like we keep stressing really, you need to meet with an advisor and get your own personal plan put into effect.
David Scranton: For that, yes, you really do, you need to have someone who can proactively plan how to help you save tax and then most of the time tax accountants, tax repairers don’t do this because they’re most often reactive trying to help you save taxes for last year. Where, as a good tax advising, financial advisor can help you plan in the years to come forward as to how you’re going to reduce your taxes.
Morgan: And, speaking of the years to come. What about beneficiaries? Let’s talk a little bit about that. How the beneficiaries factor into RMDs and will they inherit my assets after my death, do they also inherit my RMD’s and do they inherit the taxes on them?
David Scranton: Well, yes, the basic rule is, when you’re gone, that your heirs have to pay taxes on all of your retirement accounts within five years, there are some exceptions whereby a beneficiary, if a beneficiary is listed on the IRA in full and cases beneficiary, they have to be listed there. No, you can’t just have it go through your state and if that’s the case, then that beneficiary can take over that IRA, use another part of IRS Publication in 5090, keep that IRA intact for the beneficiary’s lifetime and take out little tiny required minimum distributions based upon his or her life expectancy. So, if what we’re talking about through majority of the show, of course, is satisfying your required minimum distributions, from interest or dividends so that we can keep your principle intact, then you want to make sure that that principle doesn’t go to uncle Sam, you want to make sure that principle goes to people who you really care about.
David Scranton: Makes sense, correct?
Morgan: Yes, well we are already out of time today, so thank you so much for helping us navigate such a complicated and convoluted issue.
David Scranton: And more complicated than people think, Sure.
Morgan: Absolutely. Well, as always, I look forward to your final thoughts.
David Scranton: Final thoughts. So how can you qualify for more information about RMDs? As you know, showbiz is all about the ratings and I’m not about to bribe you, our loyal income generation members for ratings, as a result to give a way some freebies, here’s how we do it. If you would like to qualify for a free RMD screening through our company Sonic and Strategies go to our website, the income generation dot com right after the show, there you can also download a copy of my white paper entitled “Understanding Required Minimum Distributions” you can also access other free materials, packed with helpful and important information, those include my special report, “The Income Generation” and my newest report entitled “Renewable Retirement Resource is the case for Fixed Income”. Again, you can find all of those as well, as register for your bribe, your free RMD analysis at the income generation dot com. I’m David Scranton and thanks again for watching.