You may not have the pictures, suntan or souvenirs to show for it, but if you’re at least 70-1/2, you’ve just finished a “vacation.” And that means you’ll have to do some work — on determining how much to take out of your retirement plans this year.
Typically, when you reach 70-1/2, you must start taking withdrawals (“required minimum distributions,” or RMDs) from your traditional IRA or your employer-sponsored retirement plan, such as a 401(k), 403(b) and 457(b). However, the sharp decline in the financial markets in 2008 led Congress to give you a one-year vacation from taking RMDs in 2009 so that you wouldn’t have to cash out assets whose value had fallen significantly.
But 2009 is over, and so is your RMD vacation. So if you must take distributions this year, you’ll need to do some planning.
For starters, you’d probably like to know how much you’d have to withdraw. You can calculate your RMD by dividing the last year’s retirement account balance, as of December 31, by a life expectancy factor, found in the Internal Revenue Service’s Uniform Lifetime Table. Your financial advisor or tax professional can provide you with this figure.
Once you know your RMD, you can then decide whether to take this amount or to withdraw more. Obviously, during your retirement years, one of your key financial goals is to avoid outliving your income, so you may want to try taking the minimum distributions for as long as you can. Also, these distributions are taxable, so the less you take out, the lower your tax bill may be. But if you need the money, won’t you be forced to take more than the minimum amount?
Not necessarily. In addition to your IRA, 401(k) and whatever other accounts might trigger RMDs, what other sources of income do you have? You’ve probably already started taking Social Security, so you can’t change that amount, though you will normally receive cost-of-living adjustments. (In 2010, however, there will be no such adjustment.) Consequently, if you want to avoid taking more than minimum distributions, you will need to look at your investments held outside your RMD-triggering accounts.
First, consider your Roth IRA, if you have one. Unlike a traditional IRA, a Roth IRA is not subject to RMD rules, so your money can potentially keep growing. But if you want to minimize your taxable distributions, you may want to tap into your Roth account.
Next, review your other investments. Specifically, consider your mix of investments. Can you adjust this mix to possibly provide you with enough income to help you avoid exceeding your RMDs? For example, can you add income-producing investments, such as bonds, without depleting your portfolio’s growth potential? Even in retirement, you’ll likely need growth opportunities to help you stay ahead of inflation. You may also want to consider dividend-producing stocks. While you don’t want to take on too much risk in your retirement years, you can find many quality stocks that produce, and even increase, their dividends year after year. (Keep in mind, though, that companies can reduce or eliminate dividends at any time.)
The RMD vacation was nice while it lasted. But now that it’s over, consider taking the steps necessary to provide you with sufficient income today without draining your resources for tomorrow.