Most owners of retirement accounts, including IRAs, 401(k)s and 403(b)s, understand that one day the IRS is going to demand that they begin to withdraw money from those accounts. The Required Minimum Distribution, or RMD, is the minimum (well-named, isn’t it?) amount that must be withdrawn during any calendar year. There is no maximum allowable withdrawal, up to the balance of the account. The process begins in the year the IRA owner turns age 70-1/2, and continues until the death of the owner, or the depletion of the account, whichever comes first. The calculation is performed the same way every year, but uses a different factor each year for the equation. All amounts withdrawn are taxable as ordinary income in the year of the withdrawal.
While there is an available 1-year RMD deferral for the year in which the owner attains age 70-1/2, today’s discussion is regarding the strategy for the withdrawals, and there is no sense bogging it down with obscure possibilities.
The timing question for taking the RMD came from a radio listener, and it proved very interesting. Setting the stage, the question was, essentially, “In a market such as this, is it better to take the entire RMD early in the year, late in the year, or spread out along the way?” The questioner did not need the income, and intended to invest the net proceeds in the market, using a taxable brokerage account. What withdrawal system, under those circumstances, would most likely provide the best outcome?
First, the calculation of the RMD amount is done on the balance in the account as of December 31 of the preceding year. The amount so calculated cannot change during this year, so fluctuations in account value during this year are a non-consideration. This also means that taxation is a non-consideration, as the taxable amount is constant, as is the owner’s tax rate. The next consideration was the need for the money, which is also non-existent in this case. Income sooner, later, or monthly did not matter.
A third consideration would perhaps be the general direction of the market. But is it? We are in a rising market, so if nothing changes substantially, the balance in the IRA will be larger in December than in January. This means that the (probable) increase in value this year will be tax-deferred, as it remained in the IRA for the whole year. If the general direction of the market is down, funds remaining in the account will have time to recover, also tax-deferred.
At first, the general market seemed to favor the later withdrawal. Upon further consideration, the current market didn’t seem to matter. Looking at every angle, our conclusion remained the same. The best strategy for RMDs is to take the money out as late in the year as possible. Conversely, contributions should be made as early in the year as possible. Either side of the argument favors keeping funds in the tax-deferred account for as long as possible.
For people who aren’t in the enviable position of not needing the income, this strategy should work fine. Many people, however, do need monthly income provided by RMDs. There is no problem taking the RMD in installments during the year. Optimizing is not always an available option. But for the fortunate folks, the strategy of “early-in, late-out” should provide good long-term results.
Van Wie Financial is fee-only. For a reason.
Aren’t you glad now that we didn’t pay attention to the media in 2016, as they whined for weeks about the Armageddon a Trump presidency would wreak on the economy and the market should he be elected? Strangely, they never seemed to offer an explanation for their gloomy outlook. Were they afraid because Trump promised lower taxes and de-regulation?
Many of us remember clearly the results of prior application of free market principles. Whether Democrat (JFK) or Republican (“W” and Reagan), when taxes were cut, the economy was unshackled, and free-market principles were allowed to work, jobs were created, profits rose, incomes rose, and the markets followed suit. After all, business conditions drive markets, whether up or down.
Since it works every time its tried, the only question left was how Trump (a former Democrat, like Reagan) would govern. Most of us were concerned that he would be less conservative, economically speaking, than he portrayed himself. But, as the policies of the new Administration became increasingly clear, the business community realized that things were getting friendlier. Since businesses are primarily run by rational, educated people, they reacted accordingly, creating jobs, ramping up production lines, and committing resources to what they perceived as better times ahead.
How did that work out for us? Here are a few interesting facts:
- Right now, there are more people working than ever before; over 160 million, in fact, which resulted from the creation of about 1.9 million jobs in 2017
- The US GDP has never been higher, having reached about 19.5 Trillion on an annualized basis
- The DJIA closed at record highs 71 times in 2017, crossed over six 1,000-point milestones, and arrived near 25,000, having set new records on average 1 day of every 4
All this begs the question, “Do any of the naysayers ever have to justify their inept suppositions?” Hardly. There are many lessons we should take away from the last 14 months. Here are some of my highlights, with some analysis:
- Do not confuse political leanings with analysis, as we are all prone to “confirmation bias”, meaning we find it easy to believe things that fit in with our political inclinations
- Markets, for the most part, are driven by profits, not by political parties or presidents
- Generally, the market is looking between 6 months and 1 year ahead, and estimating the upcoming business environment
- Although the business and personal tax cuts were already factored into the market, the outcome is very positive for business in 2018 and beyond
One feature that can’t be overlooked this year was the lack of volatility in the market. Coupled with many investors’ market acrophobia, it will be difficult for uneasy investors to hold on when volatility returns. Base your activity on the economy, rather than daily volatility.
The new Tax Law has been signed and delivered, but it is not sealed yet. There are several loose ends, ambiguities, and errors in the quickly-produced law that will be ironed out over coming weeks. Still, the best bet is that most Americans will be better off, tax-wise, than they were under the old Tax Code. This is a positive indicator for the economy, and by inference for the markets.
As fee-only financial advisors, we have a fiduciary duty to learn as much as possible, as soon as possible, about the tax law changes, enabling us to better serve our clients’ tax planning needs. Future Blogs will address changes in tax planning strategy.
Van Wie Financial is fee-only. For a reason.
Adam Van Wie, chief operating officer of Van Wie Financial, said that in combination with an iPad Pro and Apple Pencil, OneNote lets him take notes in a client meeting right on the screen. Notes are stored in the cloud and automatically synced with a CRM. “This is the best way I have found to capture all client interactions in detail, and it is always easy to go back and check the notes at a later date,” Mr. Van Wie said.