Ask Merriman: Required Minimum Distribution (RMD)

Q: I turned 70 ½ in 2016, but waited until March 2017 to take my first required minimum distribution (RMD). I planned to wait until 2018 to take my next distribution. Am I understanding correctly that I must take the second RMD in 2017, too?

You are only allowed to delay your RMD the first year you take it. You can delay as late at April 1 of the year after you turn 70 ½.

In every subsequent year, the RMD must be completed by December 31 of that year. If you delay taking your RMD the first year, it means you will have to take two RMDs in your second year.


 

Q: Are Roth accounts subject to an annual required minimum distribution (RMD)? I thought only traditional retirement accounts were, but I’ve been hearing differently.

Roth IRAs are not subject to an annual RMD. However, if your employer offers a Roth 401(k), that is subject to annual RMDs upon reaching age 70 ½.

Fortunately, if you want to avoid taking distributions, it’s possible to complete a rollover from the Roth 401(k) to the Roth IRA. This should allow you to avoid having to take an annual RMD from your Roth money.


 

Q: Do the required minimum distributions (RMDs) from IRAs that become effective in the year I turn  70 ½ apply only to IRAs, or do they also apply to 401(k)s? More specifically, if I am still working full time, does the RMD requirement apply to my 401(k)?

If you’re still working when you turn 70 ½, you may not need to take an RMD from the 401(k) at your current employer if the following conditions are met:

  • You’re employed throughout the entire year
  • You own no more than 5% of the company
  • You participate in a plan that allows you to delay RMDs

You must take your first RMD from the 401(k) the year you retire. In that year, you have until April 1 of the following year to take the distribution. However, if you delay, you‘ll end up taking two RMDs the second year.

The RMDs that become effective the year you turn 70 ½ still apply to all traditional IRAs, and all other 401(k)s and Roth 401(k)s.


 

Q: If I decide to give my RMD to my church, do I need to give the entire withdrawal amount required by the IRS, or can I just give a portion and keep the rest for other living expenses?

You don’t need to give the entire RMD amount to your church (or any charity) to complete a Qualified Charitable Distribution (QCD). The QCD can be less than or more than the RMD, up to a $100,000 limit per taxpayer per year.

A taxpayer with a $19,480 RMD in 2017 could certainly make a $5,000 QCD, and take the rest as a regular distribution for living expenses.

The key points to remember when completing the qualified charitable distribution from an IRA to a charity are that the IRA owner must:

  • Already be age 70 ½ on the date of distribution.
  • Submit a distribution form to the IRA custodian requesting that the check be made payable directly to the charity.
  • Ensure that no tax withholding is being made from the QCD to the charity.
  • Send the check directly to the charity, or to the IRA owner to be forwarded along to the charity.

 

Do you have a question about investments, taxes, retirement or insurance? Send it to “Ask Merriman” and one of our financial advisors will help you find an answer.

Convertible bonds as an asset class?


Please share your view of convertible bonds as an asset class for folks entering retirement.


Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.

We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution. (more…)

Adding bonds in preparation for retirement


At 61 years old, what is the best way to transition from an all stock portfolio to a 60% stock 40% bond portfolio?

 

This is a difficult question to answer without knowing your specific set of circumstances. To narrow the scope I will assume the following: 1) you will retire at 65, 2) you will take a 4% annual distribution from the portfolio upon retirement, and 3) you are using a globally-diversified portfolio like the one we outline in The Ultimate Buy-and-Hold Strategy.

Regarding the third assumption, it is extremely important to understand that different portfolios have different risk characteristics. A 60% stock 40% bond (60/40) portfolio allocated to the S&P 500 and high-yield junk bonds is entirely different and much riskier than the one discussed in the aforementioned article.

That said, I would make the switch immediately. With four years until retirement you cannot afford to subject the entirety of your portfolio to the risks associated with stocks.

For perspective, consider that the financial crisis cut the average stock portfolio value in half. Taking distributions from an all-stock portfolio during such a time period has disastrous consequences on the longevity of your assets. This is why, as investors near retirement (the distribution phase of a portfolio), they should – as you’ve indicated – consider adding a preservation component (bonds) to their portfolio.

If the goal is to achieve a 60/40 allocation by retirement, many people will initiate the transition process around the time they reach age 50. This longer time frame for transition allows the use of ordinary cash flows and rebalancing opportunities to make it a cost-effective and natural process. Your situation calls for a less subtle shift. Nonetheless, it is a shift in the right direction and, as mentioned above, I would proceed.

How can I get hurt holding bonds?

I am considering buying bond funds and would welcome your recommendations. I recently read in Time magazine that you could get hurt if you’re invested in a bond fund. How can I get hurt holding bonds?


Many people think bonds are risk free, but that is not actually true. There are multiple risks associated with bonds, but they can be an extremely important component of a portfolio despite those risks. And, if properly allocated, they can provide a level of security above and beyond the equity markets. Of course there is no free lunch, and the added stability of bonds requires a tradeoff. Namely, you are foregoing the equity premium associated with stocks.

We recommend using a mix of high quality short- and intermediate-term government and Treasury issues. For tax-deferred accounts we include Treasury Inflation Protected Securities (TIPS). This allocation is purposefully designed to be very conservative. Nonetheless, it is still subject to certain risks. Interest rate and inflation risk make the top of the list. You can alleviate the risk of inflation through the use of TIPS. Interest rate risk is somewhat of a different story.

There is an inverse relationship between bond prices and interest rates. As rates rise, bond prices fall and as rates fall, bond prices rise. Longer-term bonds are hit hardest in a rising rate environment; short-term issues are hurt the least. Of course shorter-term issues generally pay less interest. If you want an appreciable return – especially in today’s low rate environment – you need to extend beyond extremely short-term debt. Our solution is to limit risk exposure and also gain some additional yield by using high quality short- and intermediate-term US government and Treasury debt.

Where is the best place to put money gifted to children?

 

I have 5 nieces ranging in age from 2 to 14. We want to give them money instead of toys for birthdays and Christmas. We are talking about $25 each for birthdays and Christmas for now. That’s only $50 per year until we can increase it. Where is the best place to put that money?

The ability to delay gratification goes hand in hand with long term success.  Not only will your gift help provide financial security but it will set an important example.  Sure, every kid would love to have the latest and greatest toy.  But – at least to us boring adults – the prospect of an extra several thousand dollars for college, retirement, or a down payment on a home is much more appealing.  Granted this is not as tangible and doesn’t present as well to a 7 yr. old as a box of Legos, for example.

The option you choose depends upon the circumstances of each child.  If the goal is to fund college my first recommendation would be to use the West Virginia Smart 529 Select plan.  This plan has a low minimum initial investment and offers age-based portfolios that allocate amongst stocks and bonds based upon the beneficiary’s age.  As the child approaches the distribution phase (college) the portfolio automatically adjusts to a more conservative allocation.

However, the West Virginia does assess a $25 annual maintenance fee for smaller accounts.  The details of which can be found in the aforementioned link.  In your case it may be best to explore the 529 plan associated with your state of residence.  When the account meets one of the exceptions for the $25 West Virginia plan fee you can roll the assets into it.

Another option would be contributing to a custodial account such as a UTMA or UGMA.  The downside to a custodial account is that there are no real tax advantages.  However, if the child is not going to go to college it may be a sensible option.  Unlike 529 plans the only restriction for a custodial account is that the money must be used for the presumed benefit of the minor.  As mentioned above this would be an appropriate vehicle to save for something such as a down payment on a home.

Finally, once the kids begin to earn income you have the option of helping them set up an IRA.  What I love about this option is the time horizon and the shared responsibility.  Not only could you contribute $50/year, but you could encourage them to do the same.  Again, this is setting an example that will help shape their perspective and increases their chances, in this case for retirement success.

At the end of the day the foregone toy will be a distant memory.  More importantly, you will have made a lasting contribution to the financial security and education of your nieces.