In this month’s edition of “Money Matters,” Scott discusses the recent changes to retirement plan distributions and key factors to consider when thinking about retirement plan distributions, as well as strategies to minimize the taxes owed on those distributions.

Money Matters: Retirement Plan Distributions & Taxes Transcript

0:00:00.0 CJ: WTIP is pleased to bring you another edition of Money Matters, a monthly feature intended to help us understand more about managing our finances. Scott Oeth is a certified financial planner and adjunct professor. He's taught hundreds of financial professionals, retirement planning and wealth management strategies, and he joins us now by phone. Welcome Scott.

0:00:20.8 Scott Oeth: Good morning, CJ.

0:00:22.3 CJ: So what are the rules around when you have to begin drawing from your IRA or 401k accounts. Like how much can be drawn down or needs to be drawn down each year, and how do those withdrawals affect taxes and that sort of thing?

0:00:36.9 SO: Yeah, great question. I know you'd wanted to talk about this, and I'll say right up front, there's some general rules we'll hit, but this could be a super complicated subject. When I taught this, it's a semester-long course for professionals in the field, and that's really just covering the basics. So I highly encourage people, consult with your own tax and financial professionals 'cause there are the general rules and then there's plenty of exceptions and details. But generally, if you're talking about your IRA, 403b, your 401k plan, these tax-sheltered retirement plans, you can start taking the dollars out at age fifty-nine-and-a-half. There is a different rule for 401Ks if you separated from service at age 55. But to your question, when do you have to start taking them out? And there's a rule that's called Required Minimum Distribution, RMD is what you'll often hear, and that's age 72.

0:01:32.3 SO: Now, this is new. It used to be a seventy-and-a-half, but when you reach age 72, there is a distribution table. You take a look each year at your balance of your retirement accounts on December 31st, and you go to this IRS table and they have, essentially it's a life-expectancy factor, and that becomes the denominator. So each year you look at the balance of the account and you divided it by that factory on the IRS table, and that tells you how much you're required to take out the account and pay tax in that next year.

0:02:03.5 CJ: Okay, so that's gonna change each year as you age.

0:02:06.9 SO: Yeah, it changes as you age, so that denominator gets... The number gets smaller. So the amount that you take out, for instance, when you're at age 72, the divisor is 25.6. That's about 4% of your retirement account you have to take out. But as you hit age 100, the number becomes 6.3. That's almost 16% of your account that the IRS wants you to take out each year, and then the other thing, it's the value of the account is gonna be fluctuating with market ups and downs and depending how you've invested in there, so it does change each year.

0:02:41.0 CJ: Okay, well, okay, so there's been some important changes to these rules recently you've mentioned, so what changed?

0:02:50.5 SO: Yeah, a lot has changed. And we went for quite a while about real significant changes, but this was 2020 in so many ways has been an interesting year and in terms of retirement distributions, probably the more boring type changes. There was what was called the SECURE Act, that was an act of January 1st, and that's setting every community up for retirement. And there were a few significant changes there. The one that we mentioned, this rule that had been in place for ages, Required Minimum Distribution starting at age seventy-and-a-half, they pushed that up to age 72. So they took into account that folks are living longer, some are working longer. They're letting you keep... Continue to invest in IRAs while you're working longer, which is great. But that RMD age doesn't start till age 72. So for some folks, if you don't need the money, you don't necessarily have to take it out as soon. Another big one that I think has not gotten enough awareness is there's a significant change in that, CJ, all these dollars that have been built up in IRAs and 401Ks and 403b plans, they were put in pre-tax unless they are elected to be Roth after tax contributions.

0:04:02.8 SO: The income tax needs to be paid on those at some point, either when that participant takes the money out in their retirement or when it passes on to a beneficiary. And the rule used to be a beneficiary, your child or grandchild could take that IRA plan or that 401k plan, and they would follow that same required minimum distribution table, but they would typically be much younger. So they could do what was called a Stretch IRA, and they could leak the money out over a very long time period over their life expectancy. If my son is 50 when he inherited my IRA, he could pull the dollars out over a very long time period to minimize the tax pipe. That's changed now to SECURE Act. It's now, the funds need to be completely taken out of plan within 10 years. So if you're in a position where it looks like there may be a significant inheritance that's being passed on or any dollar amount really, that's a new planning consideration is, should you look more seriously at something like a Roth conversion or gifting now or changing your estate planning documents to be in alignment with it.

0:05:08.1 SO: So those are two big things with SECURE Act and I should definitely mention the CARES Act, Coronavirus Aid Relief and Economic Security Act. This came out in early March, and they added a few changes. It's a really expansive bill, but you could do what's called a Coronavirus-Related Distribution, a CRD, yeah, of up to $100,000. And this is all new for this year. It's just an emergency action, recognizing that some people have been very seriously impacted by this, and they might need access to their retirement plan dollars. So if you think you...

0:05:45.8 CJ: Yeah, so they could take the money out, but they'd still have to pay tax on it. Correct?

0:05:50.1 SO: Yeah, but it's written in a very unique way. You can take out up to $100,000 if you meet some of these qualifying restrictions around who's impacted, and then you have up to three years to pay it back. And there'll be minimal tax penalty, no 10% penalty, which there usually is if you take the dollars out before age fifty-nine-and-a-half.

0:06:11.4 CJ: Got it.

0:06:11.9 SO: So it really is a special clause, and if you're in that situation, look into the CRD, Coronavirus-Related Distribution and consult with your experts. Do your homework and see if it makes sense for you. The other big one is these required minimum distributions we've been talking about. They were waived for 2019 and 2020, so if you're in retirement and you've been taking those, you don't necessarily... You still can, you can always take the money out if you need it, but if you don't need the dollars, you have the ability to let them stay in that IRA or 401k plan for 2019 and 2020. And that's important because those dollars that come out, they start filling up your income tax return. We have a stair-step system. If those dollars aren't coming out, maybe that creates some room in your tax planning for other tax strategies.

0:07:03.9 CJ: Okay. Are there any key financial planning strategies around the retirement plan distributions?

0:07:10.7 SO: Oh, so many, CJ. So many. I think a couple of really big ones that apply to most people and something to take a key look at. There's a whole lot to think about around social security planning and how that coordinates with dollars you may have saved in IRAs, 401Ks, 403b plans. So when you start Social Security, if you're a married couple, do you both start at the same time? You can start as early as age 62, but you take a reduction in benefits. Most people's full retirement age is in the 66-67 range. You can actually delay taking Social Security up until age 70, and you get a really nice... The way it is now, they've been crediting an extra 8% per year build up. So for folks who don't actually need the dollars, maybe they're still working or they have other assets, delaying sometimes makes sense if they feel confident about their longevity and have other dollars. That's a big one.

0:08:12.3 SO: Roth IRA conversion, this is a big topic. This tool looks potentially more valuable than ever with this push-back requirement of distribution, this mandatory 10-year pay-out. We talked about this on this show back in May, CJ. So folks are listening, I think it's great, you've been capturing these audio files and putting them on the WTIP site. The May episode, we talked about Roth IRA conversions, but that's something I think folks wanna take a look at each year, consider, do you want to convert some or all, probably more likely a portion of your IRA accounts if you have room in these lower tax brackets.

0:08:51.3 SO: And then just the biggest one is, it's a big shift in retirement, going from investing for the long-term, investing for accumulation, to switching your portfolio and saying, "How do I invest it so that I can meet distributions each year in the near term and protect some portion of the portfolio that still allows for long-term growth to stay ahead of inflation?" Which is a real, real risk in retirement. If you get too conservative, if your investment's too early, you run the risk of losing purchasing power over 20, 30, 40 years. So that's a real balance, and then just figuring out the strategy of how can I optimize these dollars I have? Enjoy them early in my retirement, get the full benefit of them, but also don't run the risk of running out. And that's really a big part of good financial planning, and we talked about that on Money Matters back in August. So there's another file on that as well.

0:09:47.6 CJ: Okay. Well, just what occurs to me is, so a lot of us are working longer. So if we're working, we have to, at 70, start collecting Social Security and we have to take a minimum... I'm sorry I'm blanking. The distribution. The distribution. So now you have three incomes that you have to pay tax on. So can you take the distribution and put it into a Roth IRA?

0:10:15.1 SO: Well, so at 70, you would have to start taking Social Security, and now the Required Minimum Distribution is 72. So you'd have a few more years there, a gap. Sure if you were still working and earning dollars, you could still contribute to an IRA. That was part of the new SECURE Act. There wasn't an age cap on that.

0:10:33.9 CJ: Is there any age limit on that? If you're working at 80, can you still be contributing?

0:10:38.6 SO: If you're still working, you can now still be contributing.

0:10:40.9 CJ: Okay. Wow, lots of information and I so appreciate it. And thanks for giving us the months to look up on the WTIP website, the Money Matters for May and August to flesh this out even more. So I appreciate it so much.

0:10:57.0 SO: Sure thing. Yeah.

0:10:58.9 CJ: Yeah. We're talking with Scott Oeth and we'll be talking finances with Scott on the first Wednesday of the month on North Shore Morning going forward. Anything else you'd like to add, Scott?

0:11:08.0 SO: Well, I'd just like to say again, this is an especially complicated area, and there's a lot of big decisions that come into play. We didn't even touch on pension decisions for folks who have those or other issues. And so, this is really a point in time where I think even if people had been feeling confident that they were a good do-it-yourselfer, it might be time to get a check-up with a good CPA, a certified financial planner, consult, because there is just a real convergence of complicated investment, estate planning, and tax issues that all come into play here at retirement. And a lot of them are one-time, big decision that you wanna make good ones 'cause you'll be living with them for the rest of your life. Yeah.

0:11:49.8 CJ: Well, it sounds like we have another topic lined up for a future Money Matters.

0:11:54.3 SO: I think so.

0:11:56.0 CJ: Alright. Thank you, Scott.

0:11:57.0 SO: Thanks a lot CJ. Great talking with you.

0:12:00.3 CJ: Alright. Bye-bye.