Wednesday, January 26, 2022

The ABCs of RMDs

One of the most daunting financial aspects of retirement, especially for people who have been diligent savers throughout their working years, is taking required minimum distributions (RMDs) from their tax-deferred retirement savings accounts beginning at age 72. RMDs can have a significant impact on a retiree’s income tax liability and lifestyle.

New RMD tables went into effect in 2022, so this is a good time to discuss RMDs. This post will discuss basic facts about RMDs, the new IRS life expectancy tables, RMD calculations, RMD tax implications and tax withholding, tax penalties for incorrect RMDs, tax-saving strategies, and options for using money that is withdrawn.

RMD Definition- RMDs are the amount of money that investors age 72 and older are required by the IRS to withdraw from tax-deferred retirement savings plans (e.g., 401(k)/403(b)/457, TSP, SEP, and Traditional IRA accounts). The amount of money that is withdrawn is taxable as ordinary income. Withdrawals are required regardless of financial need. Distributions can be taken in any manner a taxpayer wants as long as the correct RMD amount is taken annually. Specific methods include regular monthly withdrawals or large lump sum withdrawals at the beginning or end of each tax year.

New IRS Tables- New Uniform Lifetime (life expectancy) tables became effective for RMDs beginning January 1, 2022 and replace those in effect previously. Age-related divisors are a bit larger, which means RMDs are a bit smaller.  For example, starting in 2022, the divisor for RMDs at age 72 is 27.4 versus 25.6 for 72 year olds using the previous uniform lifetime table. This change was made to help taxpayers postpone taxes a bit longer to stretch out their retirement savings.

RMD Calculations- RMDs are calculated in a series of four steps: 1. Obtain information from account custodians about account balances on December 31 of the previous calendar (tax) year, 2. Look up the life expectancy factor in the Uniform Lifetime table based on your age in the current tax year, 3. Divide the account balance by the life expectancy factor (divisor) in the Uniform Lifetime Table, and 4. Take the RMD withdrawal by the end of the distribution year.

Example: $500,000 account balance on December 31, 2021 and age 72 in 2022. The divisor is 27.4 and the RMD amount is $18,250 rounded up ($500,000 ÷ 27.4).

First RMD Calculation- The first RMD can be taken as late as April 1 of the year following the year that someone turns 72. If you postpone your initial RMD until the following year, however, you will have to take two distributions during that first year. Therefore, for most people (unless they expect a big drop in income), it is preferable to take the first RMD in the year that they turn 72 so that withdrawals are spread over two tax years rather than bunched up into one.

Still Working Exception- The only exception to RMDs beginning at age 72 is for workers who are still working for a company where they have a retirement savings plan. They can delay their beginning withdrawal date until April 1 of the year following the year they retire as long as they do not own more than 5% of the business offering the retirement plan. This is called the “still working exception" and it only applies to workers’ current employer tax-deferred employer plan.

RMD Tax Implications- Income taxes are due on the portion of RMDs attributable to pretax contributions and retirement plan earnings. This money has been sheltered from income taxes, sometimes for 4-5 decades, and the IRS wants its share starting at age 72. Large RMDs can place someone in a higher marginal income tax bracket or trigger higher Medicare Part B and D premiums called IRMAA payments. Advance planning with a professional tax advisor is recommended. Some taxpayers use Roth IRA conversions before age 72 or Qualified Charitable Distributions to reduce RMD taxes.

RMD Tax Withholding- Taxpayers with RMD withdrawals must make sure that their federal income tax withholding is adequate to cover their annual tax bill. This can be done by having additional tax withheld from their pension and/or Social Security benefits or sending quarterly estimated taxes to the IRS using Form 1040-ES. Tax-deferred account custodians can also withhold taxes. The safe harbor rule can be used to avoid under-withholding penalties. The IRS will not charge an underpayment penalty if taxpayers pay at least 90% of tax owed for the current year, or 100% (110% for higher earners) of tax owed for the previous tax year.

Tax Penalties for Incorrect RMDs- RMD rules are serious business. The penalty for incorrect (or no) RMD withdrawals is one of the highest penalty rates in tax law: 50%! The penalty is calculated at 50% of the amount that should have been withdrawn from a tax-deferred account , but wasn’t. For example, $4,000 for taxpayers who should withdraw $8,000.

Uses of RMD Money- After-tax proceeds of a RMD can be saved, gifted, or spent on things like fun activities, home improvements, or living expenses. Withdrawals can be placed in a taxable account or a Roth IRA if a retiree has earned income and does not exceed maximum income limits. 

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


Wednesday, January 19, 2022

Financial and Lifestyle Insights- Part 3


In this post, I continue my discussion of tips from webinars, podcasts, and virtual conferences that I heard during the last quarter of 2021. Below are 11 of my key take-aways:

Create Your Own TDF Glide Path- Consider personal factors when choosing a target date fund (TDF) glide path (i.e., the investment mix of TDF assets at various ages). It may be beneficial to have a different glide path than the one designated for your anticipated retirement age. For example, workers with a guaranteed pension and/or a high investment risk tolerance might want to have more stock exposure in a TDF and would chose a target date farther off in the future.

Make Tax-Advantaged Gifts- Consider “bunching” charitable donations with other tax deductions (e.g., state income tax and local property tax) every so often (e.g., high income years) to exceed the standard deduction and benefit from itemizing. Another tax-advantaged way to benefit from charitable gifts is to open a donor advised fund (DAF) with a major brokerage firm. One DAF contribution can support donations (called grants) to multiple charities over time.

Decumulate Carefully- Consider a webinar speaker’s observation that spending down accumulated savings in retirement is more complex and has higher stakes than saving during working years. Many “super savers” hoard their money in retirement because spending and seeing their balances decrease feels like a “loss.” The speaker also noted that savings can be used as a “bridge” to Social Security so that higher future benefits can accrue by claiming them at an older age.

Estimate Future Retirement Income- Consult an online calculator to understand how a sum of money (savings) can turn into a stream of income. Research studies have found that having guaranteed retirement income (e.g., from a pension or annuity) is associated with increased financial satisfaction vs. simply having a lump sum to manage. Many people do not understand how a sum of money turns into a stream of income. It is a common financial blind spot.

Leverage Compound Interest- A webinar speaker offered the following advice to first gen investors who are just starting out: “Put money in the stock market and don’t try to time it. You’ll do well over time. When there is a market downturn, stocks are on sale.” Compound interest is powerful over time and is an investor’s best friend.

Reflect on Your Successes- Think back on 2021 and write down a few things that went well for you, despite all the challenges associated with COVID-19. Feel proud about these accomplishments. As for resolutions to make changes in your life, inch into new habits and do not try to change a lot of things all at once. In addition, make a running list of lingering projects (e.g., repairs, maintenance) left over from 2021 and new projects for 2022 and keep it in one place.

Expect a Different Tax Bill- Think about all the “moving parts” that took place in your financial life in 2021. A new job, or unemployment, perhaps, or advance child tax credits. All of these will impact 2021 taxes that are due in April. Some people will likely get “caught short” and end up owing tax or getting a smaller refund than they are accustomed to. If someone cannot pay their taxes all at once, the IRS has a program to make payments in installments.

Identify Your Financial Stressors- Think about things that stress you out financially. Then you can make plans to address them and will likely find that you are not alone. Some financial stressors vary by age. A webinar speaker noted that older adults are worried about long-term care costs and outliving their money. Gen Zers are concerned by impacts of climate change on their future. People at all ages are concerned about health care costs, housing decisions, and inflation.

Practice “If/When-Then” Planning- Use this technique to anticipate and rehearse responses to financial (and life) decisions. Simply fill in the blanks: “If/When [X] happens, then I will do [Y].”  Life events to consider for “X” can include a job offer, a promotion, unemployment, divorce, widowhood, retirement, an inheritance, and more.

Document Your Impact- Save thank-you notes from people who you help, congratulatory e-mails or texts, online testimonials, and other evidence that the things that you do are making a difference to others. When you feel “imposter syndrome” at work or that nobody cares about your paid or volunteer efforts, pull these items out and read them.

Check Your FSA- Learn the rules for your flexible spending account (FSA). These plans allow workers to contribute pre-tax income annually for out-of-pocket medical expenses and child/elder care. Many people had elective medical procedures canceled in 2021 or their child care needs changed. Find out how unused funds can be carried over from 2021, and for how long, and adjust 2022 FSA contributions as needed.

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


Thursday, January 13, 2022

Financial and Lifestyle Insights- Part 2

 In this post, I continue my discussion of tips from webinars, podcasts, and virtual conferences that I heard during the last quarter of 2021. Below are 13 of my key take-aways:

Avoid Complacency- Take proactive steps to stay on top of your finances. One webinar speaker recommended checking your bank balance daily because daily swipes on a debit card add up and many people have no idea how much money they have at a particular point in time or how much they are spending on “small stuff.”

Consider “UnRetirement”- Think about what you want to do in later life. A long retirement is a terrible thing to waste! Some older adults are choosing to continue working by “job crafting” work that provides flexible schedules and freedom from administrative tasks. Benefits include meaning and purpose, social engagement, mental activity, and creativity.

Mitigate Investment Risk- Create a diversified investment portfolio through all types of market cycles to buffer market volatility and mitigate various types of investment risk. Continue to expect market volatility related to the pandemic as different COVID variants (e.g., Delta, Omicron) emerge and weigh against a global economic recovery.

Schedule Structured Time- Create a framework for yourself and put regular activities (e.g., exercise) on a calendar. This is especially true for people who have had their time use change as a result of COVID-19 or retirement. Schedule activities to create daily time structure. It can help reduce the anxiety associated with feeling adrift and “unmoored.”

Beware Online Investment Advice- Ask questions about “influencers” who provide financial advice on social media. Do they have any credentials? Is the content creator trying to sell something (e.g., some influencers sell online courses)? Does something sound too good to be true? and Can you verify the information presented from reputable sources?

Rethink Your View of AFS- Reconsider how you view alternative financial services (AFS). It is a myth that people use AFS because they don’t know any better. Many Americans live with income volatility, especially from second jobs. Some people use AFS because they live “on the edge” and bills can be paid immediately vs. waiting for a check to clear.

Plan Around Inflation- Consider the impact of inflation on purchasing decisions made in 2022. The U.S. economy recovered faster than many producers expected last year and inflation is expected to remain elevated before moderating. Used car prices had one of the biggest price increases in the core inflation rate, which strips out food and energy. Consumers might consider postponing a car purchase, if they are able to, and “sit out” the current inflationary period.

Think Tax Efficiency- Plan ahead to pay the least amount of taxes legally due on retirement savings. Tax efficiency can have a significant impact on portfolio longevity. The aim is to pay taxes at the lowest possible tax rate and avoid being pushed into higher tax brackets with required minimum distributions (RMDs). Roth IRA conversions can help do this if someone can pay taxes at a lower tax rate today and avoid taxes at a higher tax rate on multiple streams of income later.  

Be or Find a Financial Role Model- Share your financial successes with others and look for role models that look like you. Otherwise, the concept of “building wealth” feels unattainable and people develop a “That is something for rich people” attitude. Authentic role models show others that success is possible. Examples really matter!

Make Plans for Long-Term Care- Consider your “default option.” Do family members accept the obligation to provide care? If not, then what?  Fear of long-term care  expenses often holds older adults back from spending their retirement savings “in case they need it.” A proactive plan (e.g., LTC insurance or self-insurance) can help alleviate this fear.

Consider Your Computer- Windows 11 arrived during 2021 and Windows 10 support will end on October 14, 2025. That gives computer users almost four years to prepare. Most likely, if your computer is 3+ years old, it cannot be updated to Windows 11. There is a PC Health Check app from Microsoft that can tell you if your computer can run Windows 11.

Juice Your Credit Score- Consistently pay bills on time and keep your credit utilization ratio (i.e. credit used divided by total amount of credit available) low. Closing accounts will reduce the amount of credit available and could increase your utilization ratio. Young people cannot get “perfect” scores because they have not used credit for a long enough time.

Reframe “Retirement”-  Young workers will likely respond better to the words “financial freedom” or FI (financial independence) than “retirement.”  One webinar speaker noted that it is time to “retire the word retirement” and instead uses the phrase “F U Money” with young adults, an acronym for “Future You Money” and saving for your future self.

Thursday, January 6, 2022

Financial and Lifestyle Insights - Part 1

 As long-time Money Talk blog readers know, I love to learn by attending webinars and conferences and listening to podcasts.

Then, to make sure that key points stick in my mind, I review my notes and summarize them for readers.

As you set goals for 2022, below are twelve tips from presentations that I heard during the past few months:

Deal With Debt- Do not be ashamed of how you got into debt. Make a plan to dig out from under. Two good options include adding extra money to payments using the snowball (paying extra on smallest debts first) or avalanche (paying extra on highest interest rate debt first) methods. Non-profit credit counseling agency services may also be useful.

Name Your Savings- Identify a purpose for savings/investment dollars such as “new car down payment fund” and “vacation fund” and “financial freedom account.” People who have an emotional attachment to their savings (versus just saving for savings sake) are more likely to delay gratification, set aside savings, and keep their savings intact.

Think 10 Percent- Act upon this verbatim comment from a webinar speaker: “You can generate a lot of wealth by investing ten cents of every dollar you make (i.e., 10% of gross income) over your entire working life.” Example: $5,000 of savings if you earn $50,000. Be the CFO (chief financial officer) of your financial life starting today!

Plan for Later Life- A podcast speaker noted “when you plan for retirement, it is easy to forget that you also need to plan for getting older.” Middle-aged adults and recent retirees have a hard time picturing themselves at age 80 or 90. Topics to consider include housing, solo aging, sources of long-term care (if needed), and the cost of long-term care.

Be Joyful- Spark more joy in your life. A webinar speaker noted that joy “is a feeling of grinning inside.” Speaking specifically about finding happiness in later life, she advised viewers to experiment with what makes them joyful, take risks, and do more joyful activities.

Reduce COVID-19 Risk- “Wear a mask indoors and keep a distance away from others when you do not know their vaccination status,” advised a webinar speaker. This includes many public events where you are near strangers. Even if people are vaccinated, they can still get COVID and be asymptomatic. The virus thrives in cold and dry environments. This speaker also advised reducing COVID risk by staying away from indoor dining and “happy hour” situations.

Learn Key Economic Concepts- Review these four key concepts shared by a webinar speaker: 1. “There is no such thing as a free lunch” (TNSTAAFL), 2. Opportunity cost (the cost of foregone alternative decisions and actions), 3. Supply and demand, and 4. Behavioral finance (people do not always make rational choices).

Think Positively- Remember that “what people think about, they bring about.” Mindset is such a critical component of success with finances and in life. Small actions can lead to big results over time. One of the most important financial concepts that young adults can learn is the awesome power of compound interest and long-term investing.

Live a Healthy Lifestyle- Practice healthy habits (e.g., nutritious diet) that affect how long and how well you age. It is never too late to start living a healthy lifestyle. Try to stave off diabetes, which increases the risk of Alzheimer’s disease. Obesity also increases the risk of dementia. Mental exercise (e.g., games and socializing) help protect aging brains.

Practice Powerful Habits- Adopt habits with the power to improve your life. There are three components of habits: 1. Cues (triggers for habits to start), Routines (habitual behaviors themselves), and Rewards (outcomes that increase motivation). Habits are like compound interest: they don’t feel like much day-to-day but their outcomes add up over time.

Be an Organized Entrepreneur- Follow these four tips shared by a webinar presenter: 1. Do market research, 2. Track business costs, 3. Use a separate bank account, and 4. Set aside 25% to 30% of earnings for Social Security and income taxes. Income taxes need to be paid to the IRS on a “pay as you go” basis in four quarterly installments.

Plan Proactively for Later Life- Beware of future costs for four areas of spending that retirees often underestimate: 1. longevity (you could live to 100!), 2. health care (becomes more expensive with age), 3. home repairs (especially for people who “age in place” and need a new roof, etc.), and 4. income taxes (when required minimum distributions or RMDs start and when a spouse dies and the surviving spouse must file as a single taxpayer).

In my next blog post, I’ll recap some additional tips and insights from presentations that I heard late last year.

This post provides general personal finance information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


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