Happy Half-Birthday, Boomers! Now Pay This Tax …

The oldest baby boomers — those born during the first six months of 1946, started turning 70½ on July 1.

Why is this date key?

Well, because age 70½ is when Uncle Sam wants you to start taking required minimum distributions, or RMD, out of your tax-advantaged savings accounts.

That also means you are going to be required to start paying taxes on that previously tax-deferred income.

According to an article in Money, traditional tax-deferred accounts such as IRAs and 401(k) plans now hold more than $14 trillion.

And even if we speculate that this money will come out of boomer accounts at the lowest possible marginal tax rate of 15%, the windfall to the government could be some $2 trillion over the course of the next several years.

But I am much more concerned with how you should navigate this looming RMD situation than I am about how much or how little the federal government stands to raise from the coming boomer RMDs.

First off, understand that if you don’t start taking those RMDs from your retirement accounts starting at age 70½, you will get slapped with a harsh penalty of 50% of the amount you were obligated to withdraw.

That wouldn’t feel good, so my first advice is to just bite the bullet and avoid that penalty completely.

Second, make sure you know how much money you have to withdraw. That amount is based on a formula calculated by the IRS that’s based on life expectancy.

For example, let’s say you just turned 70½ and have a $500,000 IRA. Based on the IRS formula, your RMD period is set at 27.4 years.

Source: IRS.gov

That $500,000 can then be divided by 27.4, which comes out to approximately $18,250 — which is your mandatory distribution this year.

The problem with the RMD is not that you have to start taking your own money out, but that you also have to start paying taxes on that money.

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To mitigate the tax bite from the RMD, financial planners recommend several strategies.

First, you can purchase something called a qualified longevity annuity contract, or QLAC, inside your IRA or 401(k). This is a deferred annuity that begins paying an income stream at a later date — typically no later than age 85.

The purchase price of a QLAC is then removed from your portfolio for purposes of figuring your RMD in the years before the income stream begins.

Basically, it lowers your overall taxable amount. However, the QLAC purchase is restricted to just 25% of your portfolio, or a maximum of $125,000.

Another, and far more common, way to sidestep the tax man here is to convert your traditional IRA into a Roth IRA.

According to a recent article in Bloomberg:

One of the main ways planners help clients facing big RMDs is strategically converting money from a traditional IRA into a Roth IRA, which is funded with after-tax money. That’s because those required distributions can push you into a higher tax bracket, said Kevin Reardon of Shakespeare Wealth Management in Pewaukee, Wis.

At some point after 59½, when a client can tap tax-deferred accounts without penalty, but before 70½, when they must, Reardon has them convert chunks of a regular IRA into a Roth before they retire. The point is to take advantage of a period when they’re in a low tax bracket.

The Roth IRA conversion strategy is a good one. But its efficacy and suitability depend entirely on your individual situation.

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My final advice here is to make sure that if you are approaching the day when the RMD applies to you, then now is the time to seek out the counsel of a financial planner or tax accountant who can help you navigate the RMD-influenced fiscal waters.

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Have you had to take a RMD? Are you approaching the point where you will? Have you figured the RMD amount into your financial picture? What are you planning to do to mitigate your tax situation?

I am curious to find out what you are doing, so please tell me by leaving me a comment on our website or by sending me an e-mail.

Good luck and happy investing,

Brad Hoppmann

Your thoughts on “Happy Half-Birthday, Boomers! Now Pay This Tax …”

  1. If you look at what you are going to pay with RMD over x amount of years it is marginal benefit to invest in a 401k or IRA . Should have just paid taxes on the income each year.
    The matching by the company Up to 6% was nice but
    If it was available way back
    When I would have invested in a Roth

    To late for me as I turned 70 this month

    I would advise anyone who is starting out go the Roth way

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