The New Retirement Challenge

Roughly 460,000 baby boomers live in NH, nearly 35 percent of the state’s population. What do they all have in common? They will lead the way in tackling a new retirement challenge: government mandated distributions from their retirement accounts (like IRAs, 401(k)s) known as required minimum distributions, or RMDs.

These mandatory distributions start when taxpayers turn 70-and-a-half years old. From that point forward, the IRS expects annual required minimum distributions from pre-tax retirement accounts like IRAs, 401(k)s, and 403(b)s. These distributions are taxable income, and if RMDs are not taken, the IRS will apply penalties amounting to 50 percent of the amount that should have been distributed.

Recent surveys find that two-thirds of this first group of Baby Boomers (those born in 1946 and 1947) are already fully retired.  Some of them and their fellow Boomers have accumulated impressive nest eggs on which to fund their retirement. Boomer net worth (homes, real estate, and financial holdings minus debt) totals some $7 trillion, an amount far larger than that held by the Greatest Generation that came before them or the Gen X and Millennials that have followed. But now, with this new milestone, a large part of that big nest egg will become taxable income as traditional retirement accounts like IRAs and 401(k)s will become subject to required minimum distributions.

Tips for Navigating RMDs:

1. Know what types of accounts have RMDs. The rules surrounding RMDs are complex and apply to any traditional pre-tax retirement plans, including 401(k) plans, 403(b) plans, SEP IRAs, traditional IRAs, SIMPLE IRAs, and 457(b) plans. Profit sharing plans and what the IRS terms “other defined contribution plans” are also covered. Roth IRAs do not have RMDs except upon the death of the owner. 

2. Take your RMDs on time to avoid penalties. The penalties for not taking an RMD can add up. The IRS web page on the topic describes an example of a married 75 year-old with an IRA worth $100,000 at the end of 2015. Based on the age of his spouse and beneficiary status, the RMD would be more than $4,000. The penalty for not taking the RMD is 50 percent, more than $ 2,000. And in this case, the taxpayer would be liable for both the penalty and the normal income tax due on the RMD.

3. Your RMDs will rise each year. It is also important to note that the percentage of the withdrawal will increase each year and is based on life expectancy tables issued by the IRS. While you may have plenty of income to cover these RMDs today, keeping a close eye on these changing requirements will be an ongoing task.

4. RMDs will impact your income tax bracket. RMDs are taxable income, and have the potential to move taxpayers into a higher tax bracket. State and federal income taxes will also apply. You will need to look at all your retirement income sources, including Social Security, non-retirement investments, pensions and similar to determine how your RMD will impact your income tax rate.

What if I do not need my RMD to afford my living expenses? Here are a few potential options to consider from:

Fund an annuity. The IRS allows taxpayers to use part of their tax-advantaged retirement account to purchase “qualified longevity annuity contracts” (QLAC), an insurance company annuity in which a lump sum payment is made in return for a stream of guaranteed payments. While there are many factors to consider, this approach may help defer a portion of RMD payments up to age 85. Holders of traditional IRAs, SEP-IRAs, SIMPLE IRAs, 401(k) plans, 403(b) and 457 plans may be eligible.

Make a charitable contribution. Congress recently made permanent a provision that allows taxpayers 70-and-a-half years of age and older to direct their account trustee (account holder) to contribute up to $100,000 a year in a QCD, or “qualified charitable distribution”, made to an organization that is eligible to receive tax-deductible contributions. The QCD must be made in the tax year in which it will be claimed, can be applied against that year’s RMD, but can’t be claimed as deduction against normal income.

Contribute to a Health Savings Account. Holders of a traditional IRA or Roth IRA can direct their trustee to make a contribution to a HSA, or Health Savings Account. This can be done only once in the lifetime of a taxpayer, can’t exceed the HSA annual contribution limit, and acts only to reduce the total account value on which the RMD is calculated.

Since it can be a complicated matter, advice from a financial professional may be beneficial.

Stephen G. Davis, founder and president of S.G. Davis Financial Group, LLC, an independent financial planning firm with offices in Concord, Nashua and Keene, writes about the new retirement challenge for Granite State Baby Boomers.