What's the best way to handle RMDs in order to save in my IRA?
What would be the best way to take RMDs in order to try to save as much as you can in an IRA. I'm thinking that if you had stocks that paid dividends, that would be the best way, so that I could use the dividends to try to keep as much in the IRA as possible. Also, are there any tax loopholes that can be applied to the distributions?
Whether stocks pay dividends or not is irrelevant; the RMD is calculated as of the closing price the previous December 31.
The way to minimize RMDs is to start converting your non-Roth retirement accounts into Roth accounts. I began at age 40 and I usually make one or more conversions each month, so that when I reach 70-1/2 my non-Roth accounts will be relatively small compared with my Roth accounts. I recommend this for nearly all of my clients. I have even told teenagers with Roth accounts to begin the practice of converting them to Roth accounts. The way to do this is to convert whatever is most undervalued and oversold, so that you pay tax at the lowest rate and so that all future gains are tax-free.
If you convert anything which ends up dropping further in value, you can unconvert or recharacterize those conversions back into a non-Roth IRA by October 15 of the following year, and then convert them a second time at a lower price. You can repeat this process as often as you like as long as you follow the rules.
Your RMD is based on the 12/31 balance in the IRA from the prior year, so how much you need to withdraw has very little to do with the actual investments. However, if you would prefer to not incur trading costs to sell investments, then an income-producing strategy (like dividends or interest) may help bolster the cash balance in your IRA for a future withdrawal...But aside from these trading costs I can't think of a major fundamental advantage of this kind of strategy. Personally, I would urge you to focus on the total return of your portfolio (i.e. growth + income) and the asset allocation rather than solely pay attention to income production. While it's important to limit costs I wouldn't let that be your only focus.
As taxes are concerned, the entire purpose of the RMD is for the government to finally receive some taxation benefits on your IRA assets. That said, there are two things you can do to help your financial plan:
1) First, although you're required to distribute funds from the IRA and pay the associated taxes, this doesn't necessarily mean you have to spend it. Consider simply rolling this RMD into a taxable investment account and maintaining a strategy that is in line with your financial objectives.
2) Second, consider an approach to converting some of your IRA assets to a Roth IRA. Assume you have a portfolio that falls in value but you expect it to recover at some point. After that portfolio declines it can often make sense to convert some of the funds in the IRA to your Roth, while paying taxes at relatively depressed levels. I've heard some refer to this as "buying taxes on sale". This strategy should absolutely be discussed with your tax advisor or financial planner before doing anything.
Of course, this is for general informational purposes only. If you'd like to talk specifics, feel free to shoot me a call or message.
Adam Harding | Investments & Planning