The end of the year is coming fast — just enough time to do a proper job with the dreaded required minimum distribution that investors of a certain age must take from their retirement accounts. This year’s deadline is Dec. 29, since the 31st falls on a Sunday.
While many investors complain they’d rather leave their money in these accounts to grow, Elijah Lopez, financial advisor with Manske Wealth Management in Houston, says investors should not bemoan the requirement given the big gains many have enjoyed from the long bull market for stocks, and the danger of a pullback lurking around the corner.
“With valuations at a high, I am comfortable with locking in gains for clients,” he says. “This strategy is especially advantageous for people who reinvest their required minimum distribution into their brokerage account because they have extra cash to put to work in the event of a market pullback.”
[See: 7 of the Best Stocks to Buy for 2018.]
Withdrawals from low-yielding investments in a tax-favored account like an individual retirement account or 401(k) can be put into more generous income-producing investments in taxable accounts, Lopez says.
As most investors know, traditional IRAs and 401(k)s defer tax until the investor takes money out, then tax those distributions as income rather than capital gains. To be sure of getting its cut, the federal government requires that account holders start withdrawals after turning 70.5. It requires you take a fraction each year based on your life expectancy using government tables and the account’s value the previous Dec. 31.
If the table said 10 years and you’d had $100,000 at the end of last year, you’d have to withdraw $10,000 and pay income tax on it. The exception is money that had been taxed before, like after-tax contributions you’d made earlier.
Investors who need withdrawals for living expenses anyway generally have no problem with this. But many who don’t need the money right away would prefer to leave it in the account to grow. Though one may be required to take money out, it’s not necessary to spend it, of course. The investor can reinvest it in a taxable account, though taxes will chew at the principal and future gains.
So it’s important to find the most efficient way to take sums out and to put them back to work. Since it’s a once-a-year requirement that doesn’t begin until your 70s, it’s easy to get rusty or forget. Fidelity Investments says many account holders wait until late in the year. This year only 12 percent had taken even a portion of their RMD by early November, Fidelity says.
Fidelity and other firms have online calculators for figuring the RMD, and can even make the withdrawal automatically.
The first thing to remember is that this is really important, since the penalty for missing the deadline is 50 percent of any amount that should have been taken but wasn’t. The rules say you must start withdrawals after turning 70.5, but the first one can wait until April 1 the next year. After that, withdrawals must be made no later than Dec. 31.
[See: 9 Ways to Avoid 401(k) Fees and Penalties.]
Paul Jacobs, chief investment officer of Palisades Hudson Financial Group in Atlanta, warns that delaying the first withdrawal until the next year typically means making two withdrawals in that year. Since that can push the investor up into a higher tax bracket, it’s important to leave time to weigh the decision.
Fortunately, there are no tax law changes to worry about this year. But, as in every year, the financial markets’ behavior is a key consideration because you can pick and choose the investments to unload.
It can get complicated if you have more than one account and more than one holding in each account. The rules say how much must be withdrawn, but you can spread it over the all your holdings, take it from just one, or do anything in between.
As with any type of account, it pays to sell holdings you don’t expect to rise, and use proceeds you want to reinvest to buy assets with better prospects. So the RMD should be coordinated with ongoing investment strategy and rebalancing to restore the desired mix of investment categories.
“If you have different stock and mutual funds in your retirement portfolio, you should be reviewing them year-round, not just once a year,” says Dave Du Val, chief customer advocacy officer at TaxAudit, a tax advice website.
“If you did wait until now, what to sell off depends on your overall situation,” Du Val says. “Choosing which holdings to sell depends on each individual’s assets, retirement plans, asset allocations, etc., so there is no general one size fits all answer that applies to everyone.”
Eric Heckman of Heckman Financial and Insurance Services in San Jose notes that because of big stock market gains, many mutual funds are likely to pay big year-end capital gains distributions this December, providing a source of cash or new fund shares for satisfying the RMD requirement.
[See: 7 Things That Can Derail Your Retirement Investing.]
It might be wise, if this is likely, to tell the fund company to keep the distributions in cash rather than automatically buy new shares that could lose value before you sell to make the RMD withdrawal.
More from U.S. News
7 Stocks Primed for an Amazon.com, Inc. (AMZN) Buyout
9 Food-Focused ETFs to Feed Your Portfolio
What Is a Required Minimum Distribution? originally appeared on usnews.com
