What should I do with RMD funds after paying taxes if there is currently no need for the funds and I want them to grow with limited risk?
I have two annuities and a 401(k) totaling $500,000, a year’s emergency fund, and a home worth approximately $350,000. The annuities have a 10-year surrender period. I’m five years into the contracts this December. I will began RMDs in 2019. I’m currently debt free, however, I plan to do $10,000 in home maintenance projects yearly until they’re all done (replacement windows, driveway repair, etc.). My pension and Social Security should cover those expenses and I do not anticipate needing the RMD funds. I also do not plan to start an income stream from the annuities before the surrender period ends. They both have a death benefit and a 10 percent free withdrawal option that I also don’t plan to use.
At this point I’m not sure I want to keep the annuities after the surrender period, but don’t know if I should start taking the free 10 percent now and invest it, or wait five years and start taking it then. I don’t have life insurance, but I have prepaid my funeral expenses. I want the $500,000 to grow and go to my son and granddaughter. What should I do to make the most of the annuities and 401(k) money with limited risk?
You're doing a fantastic job of looking at the multi-faceted aspects of RMDs. Your question is also a great one because not only does it show how complicated these can be but how imminent they loom not just for you, but for all retirees with money in tax deferred accounts.
There are several approaches that would work but I'll start with that one which seems most applicable to you (this is for informational purposes only though).
That strategy would look like this: Take your RMD and have the provider send 100% of it to the IRS. Using this as a tax payment offset, then take a portion of the remaining funds equal to the tax payment just made (be aware of tax bracket thresholds) and convert some of the remaining funds to a Roth IRA. Repeat this each year until all monies are Roth IRA.
The advantages of this plan: Roth IRAs are not subject to RMD rules.
You do not experience any difference in your income or taxes on that normal income as this is largely an insulated transaction- meaning your cash flow in retirement is unaffected.
You can leave this Roth as a tax free gift to your son and granddaughter that can continue to give them lifetime tax free growth as well!
As for which accounts, I would need to examine your situation and contractual obligations closely before increasing the specificity but if you look at the 10% free withdrawals as an optional cash account, that might provide more liquidity to maneuver this strategy, especially since you mentioned you don't think you'll keep them beyond the surrender period.
I hope this helps.
Congratulations on being in such good financial shape!
Since you mention an RMD, I assume the annuities are inside of an IRA. I'm not sure why your advisor recommended an annuity in your situation since you already had tax deferral via the IRA structure. Further, I assume you mean that you can take up to 10% out of the annuities without a surrender charge.
I'm not sure what your estimated taxable income is currently, but if you're in a reasonably low tax bracket, I'd recommend that you begin to move money out of your pre-tax accounts. This can be done by transferring an amount to a taxable brokerage account (your RMD can be handled this way). If you have additional room in a lower tax bracket, you may want to convert some of the pre-tax (I assume) 401k to a Roth 401k/IRA. This will move the investments to a tax-FREE account that your son and/or grandchild can also benefit from after your passing.
Since you are investing with your son and granddaughter in mind, you may want to consider a heavier equity allocation than you would like for yourself. Your life expectancy is probably shorter than your son, and significantly shorter than your granddaughter! Invest with their time frame in mind, not your time frame, if you don't need the money for your expenses.
Best of luck and thanks for your question.
I'd like to respond in segments with regards to the different things you mention. It is not clear if the annuities are funded with pre-tax retirement funds, thereby an IRA Annuity, or with after-tax dollars. If they are pre-tax, then you realize they have an RMD requirement which seems in conflict with not making withdrawals during the surrender period. If the annuities are indeed IRA annuities, I suggest calculating your RMDs on each of them, as well as the RMD on the 401(k) funds, then take the total of all RMDs from the 401(k) funds. Hopefully, there are sufficient funds in the 401(k) to cover all RMDs until you begin to draw on the annuities. If the annuities are not IRA annuities, just continue to my next thought.
Annuities are varied and diverse in their contractual terms. I suggest you review the terms of your annuity contract with your advisor. You do not even mention if they are index annuities or variable annuities, or if there might be some living benefit riders on one or both. Another important variable is whether or not your annuities require annuitization (essentially giving up all principal in exchange for the income stream, but there are variations on this) in order to draw income from them. My point is, you want to make an informed decision regarding whether or not you keep them beyond the surrender period. An annuity, by definition is intended to provide lifetime income. Cashing them out seems to defeat their purpose. Even if you don't need the income, you can simply take the income as it pays out and invest it elsewhere. That may keep the $500,000 preserved for your heirs even if it flows from one financial instrument to another. You also need to check the death benefit on each annuity and how that will be impacted by withdrawals taken. And your decision will also depend upon the investment performance of the annuities during the surrender period and what the cash value is at the end of the surrender period. I'm not sure what you mean by "10 percent free withdrawal option." Your overall objective should be to maximize your dollars, not necessarily maximize any one financial instrument. A solution may be to retain the annuities, not necessarily for their continued internal growth capabilities, but for the income they can produce which can then be invested elsewhere.
Likewise, it is not clear how much of the $500,000 is in the 401(k). In any event, I usually recommend doing a rollover of funds in an employer's plan, like a 401(k), to an IRA. That will provide you with more independence regarding investment opportunities and enable your financial advisor to provide advice and service on that account, which he/she cannot do as long as the funds are in the 401(k), where he/she has no direct access. There is really no benefit to leaving your money with an employer from whom you have separated.
Back to the annuities in your last paragraph. Understand that the funds in the annuity are already invested, maybe you no longer like their investment choices, or think you can do better, but they are invested. So you don't need to take money out to invest it. I'm thinking this "free withdrawal" may be an amount that you can withdraw without it being subject to the surrender charge. However, it would be subject to any applicable taxation, so it is not "free." The "surrender period," and surrender charges levied on withdrawals during that period, are defined by the annuity issuer and in your contract. Since they create the charges, they can likewise waive them as they wish.
I commend you for wanting to do your best with your savings for the benefit of your son and granddaughter. Realize that there is risk in any investment. There is even risk in sequestoring the money in a static account - that being inflation risk. Work with your advisor to measure and quantify your risk tolerance to better understand the type of investments you are most comfortable with. Again, it is not about the financial instrument, i.e. annuity, 401(k), IRA, etc. but the actual investments inside of those insturments. I suspect you have not been focused on that at all because you mention nothing about any protfolio composition (stocks, bonds, domestic, global, larg cap, small cap, etc.) yet, that is where your future decisions must be made when you ask "...to make the most of...with limited risk?".
One thing to consider is making your charitable contributions from your RMD's. This is called "Qualified Charitable Deductions" and will be probably the only way you will be able to deduct charitable contributions under the new law.
I would consider investing the money into ETF's with about 60% in fixed income such as bonds, real estate, and fixed annuities. The other 40% would be in stocks with a mixture of Large, Mid, and Small cap funds with some foreign exposure. On the bonds I would suggest a portion into Inflation-Protected bonds.
I would encourage you seek out a “Fee only” independent Registered Investment Adviser (RIA). RIA’s are fiduciaries and will have your best interest at heart. Find one who is a Certified Financial Planner professional ™ (CFP®). You can find advisers at the following websites:
National Association of Personal Financial Advisors - https://www.napfa.org/financial-planning/how-to-find-an-advisor
Financial Planners Association - http://www.plannersearch.org/
XY Planning Network - https://www.xyplanningnetwork.com/
It’s unclear that your annuities are a part of rollover IRA or not. Since you mentioned the RMD, I assume they are the retirement accounts invested in annuities.
One thing you need to understand is there’s no “free” withdrawals from an annuity. Worse, every insurance company’s verbiage is different even though sometimes they meant the same. The amount of withdrawal (you stated 10%) may be written in the contract, but you must peruse carefully to confirm when you can be free to take the money out without any penalty. When you’re still in that surrender period, every bit early withdrawal may reduce your potential income, whether it’s dollar-for-dollar or a percentage of deduction. You can either learn those contracts on your own or seek a professional’s assistance to guide you to best use of those annuities.
Regardless what your decision is, a total surrender or cash out an annuity policy is not recommended. Why? You lose all the benefits you have accumulated with the policy. If you had any “bonus” earned when you first signed up the contract, they will be gone upon surrender. Secondly, the tax. If your annuity is funded with a retirement amount, the entire withdrawal will cause you a hefty tax bill. On the other hand, if it’s a taxable account, you only pay the tax on the earning portion. Lastly, if you’re under 59 ½ when you take the annuity out, there’s a 10% early withdrawal penalty tax.
Circle back to your original question-if you do take the RMD from the annuity but have no use of it, what do you do? After you take the RMD and pay the tax each year, you can invest in a taxable account. List your children and grandchildren as beneficiaries/contingent beneficiaries and design a portfolio with the maximum tax efficiency in mind because you pay tax each year in that account. Best!