[00:00:39] Andrew: Welcome, everybody, once again to another fantastic episode of Your Wealth & Beyond. I am your host, Andrew Rafal, and this podcast you come to as many of you know is built for a number of reasons but ultimately what we’re looking to do is help business owners, individuals that are climbing the corporate ladder, and those that are already retired weed through some of the questions, the information, the misinformation out there regarding planning for retirement and whether that means tax strategies or understanding asset allocation or proper estate planning. We’re going to look high-level digging deep and today we’re excited because over the years one of the biggest questions that we get and a lot of it is because there’s so much information out there is in regard to Required Mandatory Distributions or as we abbreviate as RMDs.
So, what we’re going to do because this is a very in-depth topic, we’re going to break things down in a three-part RMD series. Today is going to be Episode 1 and that’s going to mean going through the basics of the required minimum distribution, how it relates to your IRA accounts, to your Roth IRA accounts, to your 401(k)s, how to calculate the mandatory distribution, some specific items regarding being married and having your spouse be over a certain age separated from you. So, we’re going to go through high level, the basics, answer those questions today.
[00:02:29] Andrew: Episode 2 which will be coming up is going to be dealing more with specifics strategies to minimize your mandatory distribution. Tips and other items that we’ve worked with, with clients and helping them understand how to properly and efficiently take money out of the IRAs and the 401(k)s. So, we’re going to dig more granular in the next episode and go through specific strategies that you could potentially incorporate. And then the third part of our episode, third part series, on the required minimum distributions and IRAs in general is in regard to what do you do when you inherit an IRA and how and why you don’t want to make mistakes in regard to, number one, the mandatory distributions but, number two, some of the ways in which you can make sure that those monies that you receive will effectively continue to grow tax-deferred as long as possible.
So, we’re going to break it up in three. Inside of each of the episodes, you’ll have the opportunity to download some valuable information as well as to give us a, if you have a question or you want to walk through how your RMD will fit into your strategy of the ability to do that. So, as we jump in episode number one, I do want to let the listeners know that while I’m recording this in the Bayntree headquarters, it is Sunday morning, and we do have the British Open on. Now, by the time this gets out to the public we’ll know who has won this tournament but right now it’s going down to the stretch and there are about seven people competing including Tiger and McIlroy. So, if you hear me do a scream or something like that, it’s not because I’m so excited about mandatory distributions although it is a very exciting topic. We might have seen something happen. So, just wanted to let you know that on the side note.
[00:04:28] Andrew: So, let’s talk about the basics of required minimum distributions and as many of you out there, the majority of us have had to save and contribute money to ensure that they’ll have a retirement that will allow for income and what I mean by that is saving within a 401(k) plan, an IRA, a SEP IRA, a simple, if you’re a teacher or in the hospital profession or a doctor you may have a 403(b), those that have worked for the government, the post office, etcetera, you may have a TSP which is also similar to a 401(k). So, all of these vehicles were built or allowed for to allow each of us to contribute money and in some cases, we get a tax deduction along the way. So, for instance, as you were climbing the ladder of your employment and saving money, every time you put money into a 401(k) or into a traditional IRA you got a tax deduction.
Now, those limits this year of putting money in for those that are under the age of 50 into a 401(k) it’s $18,500. So, in regard to the 401(k) maximum contribution amounts for this year, if you’re under the age of 50, you can contribute up to $18,500 and for those of you that are over 50, there is the catch-up which allows you to this year to put away $24,500. So, a lot of times we’ll get questions from clients in saying, “Well, why do I have to start taking out money from my IRA?” and before we even go to the deadlines and the dates, etcetera, think in terms of the government’s been allowing you to defer that money. They’ve received no tax dollars on that. So, at a certain point the powers that be said, “We want to start collecting at least a little bit of taxes on the money that you’ve been deferring.” Otherwise, how many of us we’ll just let it accumulate and accumulate and continue to compound and triple compounding we call it?
[00:06:39] Andrew: So, inevitably at some point you’re going to pass away and then if we went to the next generation and they continue to let it grow and then ultimately, we would have certain retirement accounts that they have tens if not hundreds of millions of dollars in it. So, one of the first real important items to remember that most of you know is when you turned 70 ½, the year you turn 70 ½ that is the first year that you have to potentially start taking money out of your retirement accounts and I say potentially because it’s just going to be based on what type of an account it is. So, for simplicity reasons, the first example we’ll go through is let’s say somebody’s retired and they have three IRA accounts and they do turned 70 ½ here in 2018.
So, what will happen in 2018 is they will be required to withdraw a certain minimum amount based on a uniform table. That uniform table is really based on life expectancies. Now, in our show notes and also on the episode notes, we’re going to have the ability for you to download of calculating your RMDs in five easy steps and this will also incorporate not just the life expectancy, the table, but the percentage. Well, the percentage the first year that you turn 70 ½, the percentage is approximately 3.65%. So, what that ultimately means is that we go back and we value the account, the IRA account value at the end of the previous year so you’re going to look at your IRAs and, in this case, if we had three of them, you’re going to look at what was the year-end value.
[00:08:39] Andrew: Let’s just say for simplicity purposes that between those three IRA accounts, there was $1 million in total. So, what you would have to pull out for 2018 is approximately $36,500. Seems pretty simple, huh? Well, a couple of caveats. Number one, the year that you turned 70 ½ which is our first year that we have to pull out mandatory distributions, the IRS provides the ability to wait to the following year to take out your R&D for 2018. So, in theory, they’re allowing you to delay. Sounds great, right? But there’s always a caveat. In the following year, the owner of the IRA will be required to pull out what they should have in 2018 which was in this simple example, $36,500, but they’re going to have to pull out another amount, meaning the 2019. They’ll have to pull that out by December 31 of 2019.
So, what’s happened now is now the individual has to pull out two mandatory distributions in the same year. And for most of us that probably doesn’t make a lot of tax sense. The reason being is that mandatory distributions that come out of an IRA or a 401(k) or a simple or a SEP, they are taxed at your ordinary tax rate, your ordinary income tax rate. So, in this example, because the individual example client will have to pull out two withdrawals in 2019 which says, let’s say roughly it’ll be about $74,000, well now that $74,000 gets added to the rest of the income they have, Social Security, maybe a pension, investment income, dividends, interest earned from the bank, real estate.
[00:10:39] Andrew: And now what would’ve happened is they could’ve been positioned to a higher tax bracket. They also may be at such a high income that they have a Medicare penalty. So, you want to be careful not to just delay because you can that first year. Now, for some of us, it makes sense to delay. It may be because in that year, again let’s use 2018 and you may have one more year that you’re earning high income and then the next year that income drops. So, it’s really important to plan proactively so here we are in the middle of the year and you don’t want to just wait until November, December and just say, “Okay. I’m going to pull it out or I’m going to wait.” You want to build that into your plan and understand how it’s going to fit in with the rest of overall tax minimization strategy. So, if you’re not having these conversations with your CPA or your current advisory firm, make sure you go in there.
Now, when we have multiple IRA accounts which most people do, wherever they’re held whether they’re at the same custodian or they’re at multiple custodians, the one benefit that the IRS gives us is that you can aggregate your IRAs and pull out the mandatory distribution, you can pull that out from one of the accounts, you can pull it out across all three. At the end of the day, what the IRS really cares about is that you have this mandatory withdrawal from these three IRA accounts. They don’t care where you pull from. They just want to make sure that you pull it out. So, in that case, what we do a lot of times is we’ll build a strategy and have maybe multiple buckets of IRAs with different purposes. Potentially, one IRA account that we’re not going to look at as touching, we may take more risk in that account. You may have an account that we’re going to have the least amount of risk that we’re going to use for the next couple of years to take out the full required minimum distribution.
[00:12:40] Andrew: In some cases, clients have annuities with lifetime income guarantees so they can be, if those have a good income, they can be a great vehicle to turn on and that can be a large percentage of your required minimum distribution allowing you not to touch your other accounts. But the key component is before you get to more of these detailed and strategic strategies of reducing or coming up with that type of game plan, you just first have to know what the amount you have to pull from. Now, here’s an important note that a lot of people aren’t aware of is that if you are 70 ½ or older, you have a 401(k) and you’re still working for the employer full-time, you are not required to take out your required minimum distribution from that 401(k) account. So, that’s important is that if you are still working, you have a 401(k) but you have three IRA accounts outside, you still have to pull out the mandatory distribution from the IRAs, but you will not have to take out the 401(k).
In our next episode, we’ll talk about some strategies that you can look at that are outside the box thinking that potentially if you are working and you do have a 401(k), ways to minimize the mandatory distribution from your IRAs so that will be on the next episode. So, the 401(k) if you are not working, you have to pull out your mandatory distribution similar to the IRA. The only difference is each retirement account that’s with an employer, a 401(k), a 403(b), of 457, a TSP, they are treated as their own meaning they’re on their own island. You cannot combine and aggregate the amount of your mandatory distributions and combine a 401(k) with another 401(k) with your IRAs. You have to treat that 401(k) separate.
[00:14:40] Andrew: So, that’s where a lot of times it makes sense for somebody to roll a 401(k) to an IRA whether they’re managing it, they have an advisory firm managing it, but that way it allows them to utilize that aggregation feature and it ultimately allows them to take more control over where they’re going to pull the money from. So, very important if you have an old 401(k), you still have to pull out the mandatory distribution and here’s the deal, guys, is that most of the time, yes, the custodian may send you a letter. The custodian is where the money is held whether it’s TD Ameritrade, Fidelity, Schwab, Trust Company of America, at an insurance company, ultimately, they are the custodians. So, they are required to send out language that says, “Here is you’re mandatory distribution,” but they are not really required to make you pull from it.
So, here is an important component is that you cannot rely on the custodian. You cannot even rely, depending on the relationship, you should be able to rely on your advisor if you have an advisory relationship but ultimately when you think of the world individual retirement account, it still comes down to you. So, think of it as the buck stops with you. If you do not pull out the required minimum, the RMD, there are very swift penalties and what that penalty would be in its simplest version is that the following year let’s say you realize you forgot to take out the RMD from a specific account. The IRS requires that you still pull it out and then taxes you or penalizes you 50%. So, it’s a huge penalty.
[00:16:33] Andrew: Now, one of the areas that we’ve seen if you forgot or got bad advice but ultimately, you forgot to take out your mandatory distribution, we have seen in the past through following certain procedures and we have a checklist to show what to do if you forgot to take out your mandatory distribution. We’ve seen the IRS be pretty lenient when it comes to that as long as you show that in everything you could once you realize that you made the mistake. But the key here is it comes back to you, so you have to be proficient in understanding how the laws work and that way it’s really educating yourself well before 70 ½ because the majority of the clients that we work with and the people that we see whether they’re individuals, executives, business owners, they do have a high proportion of their retirement dollars in retirement accounts that are going to be taxed at a later point. So, that’s where if you understand what that will look like rather than it becoming a ticking tax timebomb, working effectively in your 50s and 60s, the game plan, how we can minimize taxes in the future.
Now, a lot of you have what are called Roth IRA accounts and Roth 401(k)s. So, one of the real beauties of a Roth IRA and why we look at that as one of the more valuable types of retirement accounts is that when you turn 70 ½, the mandate does not require that you pull out any minimum distributions from a Roth IRA. So, think of the power of being able to continue to defer the dollars within the Roth and then although you can pull from it at any point, not required to do so by the government. So, what that allows you to do is really control that account and granted when you do take money out it will be tax-free but there’s a certain power in knowing that you control that particular account.
[00:18:42] Andrew: Because there’s one thing that we don’t know is where the tax laws will go. Obviously, we’re in a seven-year window here with the Tax Cuts and Jobs Act that we believe over here at Bayntree that it will probably be the lowest type of tax brackets and exemptions and deductions that we’re going to see in our lifetime and we are facing a deficit that we believe is going to continue to increase. And so, what that’s going to mean is at some point they’re going to have to revert back to the mean of where taxpayers had to pay taxes years ago with threefold higher than where we are today. So, the key component there is we don’t know what that taxes will be on your IRAs in the future. We don’t know what the minimum distribution will be. So, if you have the opportunity to build money and contribute to a Roth or effectively convert money from an IRA to a Roth is definitely something that you should look at and on our next episode, we’ll dig through on how that can be a strategy to help eliminate or reduce the amount of minimum distributions.
So, the Roth IRA there are no mandatory minimum distributions. Now, here is something that a lot of people aren’t aware of. As more and more companies are allowing employees to contribute some of their dollars into the, let’s call it, a Roth 401(k) and what that means is that you can contribute a portion of your dollars to the pretax and a portion to the Roth which is after-tax and inside of that Roth 401(k) the negative is you don’t get a tax deduction in the year that you add to it. So, for instance, myself I put away the maximum amount to my company 401(k) here at Bayntree and that is $18,500. I put part of it or 50% into the pretax where I will get a tax deduction. The other part that goes into the Roth I don’t get a tax deduction so it’s a little pain now because otherwise, I would’ve gotten a deduction on that money.
[00:20:40] Andrew: But now what I’m doing is building an account that will be tax deferred as it grows tax-free down the road when it comes out. It does not require that I pull money out except one caveat which we’ll go through and it can pass to my beneficiaries tax-free as well. Now, here’s the caveat is if you have a Roth 401(k) and you turn 70 ½ and you are not fully employed with that company so let’s say you had a 401(k), you retired, part of that money is in a Roth. Well, here’s the catch is that you do have to pull out required minimum distributions from a Roth 401(k). Now, here’s the thing though, is that you don’t have to pay taxes on it, but you do have to take out the minimum. So, one real easy way to get around that is to roll the Roth 401(k) to a Roth IRA account and then moving forward you won’t have the need to take out that required minimum distribution.
So, very important to understand how that works in relation to the type of accounts that you’re building. Also, when you turn 70 ½ you are not allowed to contribute any more money to a traditional IRA account but if you’re working, you can still contribute to a 401(k) and you always have the ability to contribute to a Roth IRA as long as you’ve shown earned income. Earned income is more so work income. It’s not going to be income that you received from investments or rental properties that are passive or even monies that you’re pulling out of the IRA. So, that’s important to know is that you can continue if you’re working or if your spouse is working, you can continue adding to a Roth IRA account. So, lots of different things to understand.
[00:22:34] Andrew: The one last thing that we’re going to finish up with today’s episode on is in regard to the life expectancy table or ultimately the amount of money that you have to pull out. So, as we discussed earlier, the first year it’s approximately 3.65%. What happens is, is every year that amount will go up based upon, in a sense, your life expectancy, government looks at them and says, “Every year you get older, you get closer to your life expectancy, closer to dying.” So, by the time you get into your early 80s, the amount of mandatory distributions is closer to the range of 6% so every year it’s going up and that means that inevitably your account can start going down. Now, remember, if you have to take that money out and pay the taxes and you don’t need it, you can reinvest it. You can position in different things. You can gift it. It’s not like the money is gone. It just can’t stay all of it growing tax-deferred.
So, here’s the one caveat regarding the lifetime expectancy tables and the amount of money that you have to withdraw. If your spouse is 10 years younger or more so at least 10 years younger than you, you can pull out your mandatory distributions based on the joint life expectancy table and the benefit here is because it’s a longer life expectancy, it means less that you have to pull from each year which could mean more money in your pocket. So, that’s a very important item to understand if your wife or husband or partner is 10 years younger or more so 10 years or more than you can utilize the lifetime expectancy table that’s joint. Now, your custodian that sends you the documentation, they’re not going to tell you this. They’re not required in a sense to. They’re also not going to know if you have money that you have other IRA accounts. They’re just going to indicate to you that this is the minimum amount that you have to pull from.
[00:24:37] Andrew: So, that’s where you’ve gotten multiple different IRAs. You have an age difference, all of these things you’ve really got to truly dig in and understand the details working with your advisory firm. Hopefully, they’re well versed in this type of arena. We work closely with our clients and their CPAs to make sure that we’re proactively planning on how to limit and reduce the mandatory distributions. In our next episode, we’re going to go through some of the strategies and tips that can be used to minimize your mandatory distributions, to maximize the tax deferral, and there’ll be some wonderful different items for you to review that you can potentially use to ensure that you are properly planning for your retirement and beyond. So, show notes, we’ll list all the different links out to what we’ve talked about. This is just the first of a three-part series.
Please forward this on to anybody that you think would benefit from it and also do not hesitate to reach out to us directly at questions@bayntree.com. If you have specific questions that you want us to review whether on the podcast or just have a candid conversation with us. We can also provide to you some guidance that you can take with you to make sure that you don’t have a ticking tax timebomb in your hands and that you effectively utilize these tax credit, the Tax Cuts and Jobs Act and ultimately look to reduce the amount of taxes that you’re going to be paying for the rest of your life. Hopefully, you found today’s show this topic of relevancy. If you’re not retired, forward it on to somebody that’s getting closer to retirement. As we say here at Bayntree, you dream, we plan. Happy planning, everybody. We’ll be back soon with the next episode. Thanks so much!
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Thank you for joining me for today’s episode of Your Wealth & Beyond. To get access to all the resources mentioned during today’s podcast, please visit Bayntree.com/Podcast, and be sure to tune in later this month for another episode of Your Wealth & Beyond.
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Investment advice is offered through Bayntree Wealth Advisors, LLC, a registered investment advisor. Insurance and annuity products are offered separately through Bayntree Planning Group, LLC. Bayntree is not permitted to offer and no statement made during the show shall constitute legal or tax advice. You should talk to a qualified professional before making any decisions about your personal situation.
