all about rmds in retirement

How Should I Take My RMDs in Retirement?

Using tax-advantaged retirement accounts to save during your working years is a smart move. By using these accounts, you are deferring taxes. However, this postponement does eventually come with an expiration date. The government will come looking for its share. This bill comes in the form of calculated required minimum distributions (RMDs) beginning when you are age 72.

What are RMDs?

Required minimum distributions are withdrawals from your traditional retirement accounts such as 401(k) or an IRA. The amount is dependent on your savings and life expectancy. RMDs are calculated and serve to collect taxes on money that has grown tax-free. CPAs oftentimes do not want to take multiple RMDs because it increases taxability. However, whether liked or not, after 72, RMDs are mandatory.

How are RMDs calculated?

RMDs are calculated based on life expectancy and the total you have in your retirement accounts. Using one of three IRS tables, your life expectancy is given a factor number which is then divided into the funds subject to RMDs to determine what you need to withdraw.

What is the best way to take RMDs?

While the best way is always to consider your individual circumstances, there are two common ways to take RMDs. First, you may want to wait until the last possible minute which would be Dec. 31 of that year to maximize your returns. Secondly, you may want the regularity of a paycheck, so you could opt into 12 monthly payouts of the RMD.

Why You Should Never Skip & How to Ease Withdrawals

Skipping an annual RMD will result in heavy penalties versus what the income tax may have been. You would be fined a 50% excise tax of the RMD you should have taken. For instance, if you did not take your RMD of $10,000 you would have to pay a levy of $5000 to the IRS—an amount far greater than the income tax you would have needed to pay. Unfortunately, no catchups would be permitted in future years and no credit is given for taking more in past years.

The bill comes due to all tax-advantaged retirement accounts. Unfortunately, there is no way to avoid this, but there are a few ways to lighten the toll. Some strategies are following:

Charitable Donation

After calculating your RMD you can donate up to $100,000 to an authorized charity of your choice via a qualified charitable distribution (QCD). A QCD does not add to your taxable income, therefore you are lessened your tax bill and are providing funds for good causes. Note the QCD must be directly made to the charity. If you accepted it as an RMD and then donated, you may still be responsible for the taxes.

The Still-Working Exemption

CPAs not retiring at 72 are exempt, but the exception only applies to the current employer’s retirement plan. So, while it does not defer all RMDs, it helps! If you are approaching 72, consolidating your retirement accounts into your current employer’s plan may be a great idea.

QLAC Delays

You could use funds from a traditional retirement account such as your IRA or 401(k) to purchase a qualified longevity annuity contract (QLAC). Doing so may reduce your RMDs. As a deferred annuity, QLAC payouts can be put off until age 85, thus putting the tax bill the retirement funds used due later as well for approximately a decade.

Roth Conversion

As the only tax-advantaged retirement accounts, Roth IRAs do not have RMDs. You have a window between when you retire until when the first RMD comes due make use of Roth conversions. CPAs see their income drop after retirement making that window for Roth conversions more than perfect to convert traditional accounts into a Roth IRA while in the lower income tax bracket.

However, this often-underutilized retirement strategy comes with some risk.

  1. Moving pre-tax money means paying taxes when moved into the Roth IRA.
  2. You may increase the portion of your SS benefits that are taxed or may trigger the Medicare surcharge tax.

Ultimately, you can have your money grow tax-free, RMD-free until you or your family need the funds.

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underestimated retirement risk: medical costs

Do Not Forget Healthcare Costs When Retirement Planning

How are you to account for health care costs while retirement planning? Oftentimes, these expenses are underestimated. Even though Medicare Part A is free and covers hospitalization, the remainder of Medicare comes with premiums and the rest of health care and drug costs are out-of-pocket even with supplemental insurance.

Why are health care costs underestimated?

CPAs transitioning into retirement often do not consider that what they were paying in premiums is not the full amount. Thinking they need the same “take-home pay” folks forget that their employer was paying a good chunk of the premium costs when budgeting and the rest was coming directly out of their paychecks. Now, facing retirement, CPAs are responsible for out-of-pocket costs and the full premium.

Familiarization with Health Care Premiums

Having Medicare Part A helps immensely when it comes to health care costs, especially since it is free. However, you will be responsible for other premiums to help cover medical expenses.

  1. Medicare Part B: In 2022, premiums increased to $170.10 monthly. Note in the future this will increase.
  2. Medicare Supplemental Insurance: For coverage not offered through Part A or Part B of Medicare, supplemental insurance is available. This will help with medical expenses, but does not cover dental, hearing, or vision.
  3. Medicare Part C: Known as Medicare Advantage, these policies vary in coverage and price, but offer options including Part A, Part B, hearing, dental, and even vision. Furthermore, Part D (prescription drug coverage) is also included.
  4. Medicare Part D: As coverage for self-administrated prescription drugs, Part D requires a co-pay per prescription. Unfortunately, some drugs are not covered.
  5. Long-term care insurance premiums: Medicare only covers so much of long-term care costs after a certain amount of time, and even then, it will add up quickly daily. To make sure you are covered, building a LTC policy to your wants and needs is best. This is an important factor to consider for retirement planning because 70% of retirees experience a long-term care event.

How much could coverage and any out-of-pocket costs be then?

Knowing Total Health Care Costs

Adjusted for inflation, in 2021 multiple studies found that retirees were spending about $6200 on premiums and approximately $6500 on out-of-pocket costs for health care. For 2022, the projected amount for out-of-pocket costs is $7000. And with rising health care costs and inflation, the average expenses are predicted to increase by a minimum of $3500 by 2030.

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Having An HSA While on Medicare

Health savings accounts can be tricky, especially when you are on Medicare. Not only do you need to meet certain criteria to have one, but you need to meet the same requirements to keep contributing to it.

One requirement to have an HSA is a high deductible plan, and you cannot have another health care plan. Since Medicare is considered another health care plan, and one that does not have a high deductible, you are not able to contribute to your HSA once you enroll with Medicare.

However, that does not mean you are unable to use your HSA along with your Medicare plan. You have stockpiled that money to help cover medical costs, and you are still able to use the HSA funds to cover expenses Medicare might not. Or to even help with Medicare premiums, copays, or deductibles.

How does an HSA while enrolled in Medicare?

To maintain and contribute to an HSA you need to be on a health plan that is a high-deductible plan. And you cannot be on any other medical insurance plan. This even means Medicare. Once you are enrolled in Medicare, you are not qualified to use your pretax dollars to contribute to your HSA.

You may be able to keep contributing if you are not enrolled in Medicare at 65. This takes special circumstances, being you are not yet retired or receiving SS benefits.

Is there a penalty for having Medicare and an HSA?

Fortunately, you will not face a late penalty if you have health care from your employer. This means, you have delay Medicare enrollment until you do retire. Retirement qualifies you for the Special Enrollment Period. The same rules apply if you are on your spouse’s employer’s health care plan.

However, if you turn 65 and do not have other coverage, you will be charged a penalty. Once you do enroll in Medicare, your Part B premium will be increased by 10% monthly for each year you did not enroll. Since you are also enrolling late without any special circumstance, you will have to wait until the Open Enrollment Period to sign up.

How can I use my HSA to help with Medicare premiums?

Since an HSA is for medical and healthcare costs, you can use the funds for qualifying expenses such as:

  • Part B, C, or D premiums
  • Medicare deductibles
  • Copays or coinsurance
  • Dental or vision
  • Over-the-counter medicines
  • Out-of-pocket costs

Can I pay Medigap premiums with my HSA?

You can, but you will have to pay taxes on the money you withdraw to do so. A Medigap plan is not a qualified medical expense, which is why you will have to pay taxes on the money taken out of your HSA to pay for it.

Are there tax penalties when using an HSA with Medicare?

You will pay tax penalties if your HSA contributions and Medicare enrollment overlap. The penalty amount will vary depending on your situation, circumstances, and how long they overlapped.

  • You will be subject to back taxes on any contributions to your HSA made after your Medicare enrollment starts. Plus, your contributions will be added back to your annual taxable income.
  • You may be hit with an excess tax by the IRS if you have contributed after your Medicare enrollment date. Excess taxes will be an additional 6% (if not more) when you take it out of your health savings account.

The IRS strongly recommends those contributing to an HSA stop doing so six months before they enroll in Medicare. Once you are enrolled in Medicare, the IRS considers the 6 months before your enrollment as a period you had access to Medicare. Stopping before that 6-month period means you should avoid any penalties that could be assessed and saves money, too.

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After Taxes Now, Tax-Free Later: Roth 401(k)

Tax-advantaged has quite the ring to it, doesn’t it? Unlike the tax-advantages a traditional 401(k) offers—funded with pretax wages—a Roth 401(k) is funded with after tax wages. Income tax has already been paid so when it comes to withdrawing in retirement, your money is withdrawn tax-free.

What exactly is a Roth 401(k)? Created in 2006, Roth 401(k)s are employer-sponsored retirement savings accounts that use after-tax money.

How They Work

While employer-sponsored, enrollment and participation in Roth 401(k)s is entirely voluntary. Payroll deducts the special funds after taxes have been taken out each paycheck. Some employers may offer matches for Roth 401(k)s.

In comparison, a traditional 401(k) and a Roth 401(k) have different tax-advantages. A traditional 401(k) reduces an employee’s gross annual income, providing a tax break now. However, regular income taxes will be due upon withdrawal during retirement. A Roth 401(k) requires income tax be paid but reduces an individual’s annual net income. But after the money is placed into the Roth account, no further taxes are owed when taken during retirement—this includes profits earned.

Much like the traditional 401(k), a Roth 4010(k) is subject to contribution limits and is based off the investor’s age per guidelines of the IRS. For 2022, an individual may contribute up to $20,5000. Those over 50 are permitted a catch-up contribution of $6500. Another perk Roth 401(k)s offer is no income limit.

Withdrawal Special Considerations

Certain criteria must be met for withdrawals to be tax-free.

  • The Roth 401(k) must be at least 5 years old.
  • Withdrawals must occur when the account holder is at least 59 ½. If before, account holder must has passed or experiencing qualifying disability.

Roth 401(k)s do require required minimum distributions. Once you are 72 the first RMD from your Roth 401(k) must be taken by the first April after you turn 72. If you are still working for the company who sponsors the retirement account, you may hold off taking a distribution.

Advantages and Disadvantages Summary

Pros:

  • Helps those who may be in a higher tax bracket during retirement (which is commonly seen)
  • Distributions are tax-free.
  • Earnings grow tax-free.

Cons:

  • Uses after-tax dollars, meaning during working years you are out that money
  • Contributions do not limit taxable income

Roth 401(k)s and Market Volatility

Sadly, you can lose money since a 401(k) is an investment into the market. However, most employers offer low-risk options like government bonds. You are always welcome to work with the plan sponsor and stir up your investment yield and risk.

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Retirees are easy targets for scams

Why Retirees are Targeted Most by Scammers

Annually, an estimated 3.5 million retirees fall victim to financial exploitation. Scammers take advantage of elders due their vulnerability. Those who are 80+ are the most at-risk group for scammers. Ruthless and always on top of trends and the latest news, scammers will try to pull a fast one via the phone, targeted emails, or even through websites.

Why are seniors targeted more than any other age group?

Money, Money, Money

With decades of saving and planning, elders are more particularly targeted due to being the wealthier, more established society members. Also, more likely to have own their homes outright, elder Americans have approximately 1.7 times the wealth than the working middle class due to their savings.

Loneliness Leads to Vulnerability

Retirees are usually empty nesters, and oftentimes loneliness leads to isolation as family grows and friends get older, too. This makes the perfect breeding ground for con artists to build a relationship with elders especially telephone scammers. Elders are always happy to get a call and are more than willing to listen to their narratives. Once the scammer can gain the retirees trust they have an easier time exploiting.

Cognitive Issues

Unfortunately, with aging comes cognitive decline. Even though seniors are reporting scams more often than younger folks, they have a harder time remembering the little details necessary. What makes matters worse is that seniors do not realize that they were scammed until sometimes weeks after the fact. Memory loss presents first with haziness, and short-term memory is the first to experience issues.

Other Health Issues Make Easy Targets

Easy for health scams, seniors are more likely to have other health issues such as cancer, autoimmune diseases, and limited mobility. The health scams will target retirees with fake remedies for these issues since they are seen as personal.

Retirement Staples

As the baselines to retirement, Medicare and Social Security are very important to seniors to maintain their health and finances. If a call or email comes through for these programs talking about issues elders are very prone to panic. The panic-inducing targeting gets retirees to act out of fear for losing their benefits or insurance. Retirees are more likely to share their information to scammers when something that important is threatened.

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Retirement Security & Behavioral Finance

Your mind is wired with cognitive biases that influence your decision making—something that does not make planning your retirement as you wish and need easy. Behavioral finance studies the impact cognitive functions, social, and emotional factors have on financial decision making. Understanding this can increase overall financial health and allow for a more secure and successful retirement.

Loss Aversion Understanding

Research shows that folks are more stressed by losing money than gaining it. This is call loss aversion. This can make investment management and retirement planning problematic. In order to achieve a risk-based retirement plan and obtain reducing those Top Ten Risks, having a basic plan is the best first step for a secure retirement. You need to know your options!

Know Yourself

Naturally, folks are risk averse—but even this instinct needs to be well-informed. Understanding your motivations and wants for retirement allows you to set goals. When brainstorming your retirement wants and goals, try different ways of phrasing them. Going with the one that feels more motivating is what you should chose.

Know How Your Money Can Buy You Happiness

Think of your retirement as a trade: time and money. You spend decades dedicated to working and retirement is now your time. While planning for retirement keep that in mind! And financially, think about what will bring you happiness. Traveling? Starting a new business after retirement? Downsizing your home and spending more time with family? Knowing how you wish to focus your money promote you to stay motivated and overcome cognitive biases as you focus.

Decisiveness is Key

Ironically, good decision-making skills comes in handy here. Understanding your cognitive biases and having your goals properly aligned means success will allow you to better make those decisions—even understanding your past decisions will help!

The basics for retirement decision making are comprehensive retirement risk understanding, risk-based testing and planning, and knowing strategic options to reduce the risks.

Be Friends with Your Future

Ever heard of present bias? This is our tendency to value the current moments more than the future ones. For example, you are more likely to spend money on something that will make you happy now than you are to invest or save it for your future self. Present bias is actually a major factor in why folks have a hard time saving and planning for retirement.

Visualize your retirement goals. Keeping in mind your future self not only will help with retirement planning, but it will help your overall well-being!

For more information on behavioral finance and how it will help your retirement and your clients’ retirement, listen to our episode “Turning Knowledge into Action” on the Retirement Risk Show.

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