RMDs In 2021

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Zach – Hello everyone Zach Holcomb here on “Retirement Today,” alongside me we have Michael Reese. Who’s a certified financial planner and founder and president of Centennial Advisors. Mike, we are finally in 2021, 2020 is behind us. And on today’s program, we’re talking all about RMDs which are required minimum distributions. Now in 2020, as some of you know all RMDs from 401(k)s and IRAs, those were waived but now we’re in 2021 and they’re back. So Mike, what are RMDs and how do they affect our planning?  

Michael – You know, that this, I think this is a great topic Zach. And as you know, it’s always our goal to help, you know all of you who are listening we wanna help you enjoy the three C’s. And those are feelings of control that you controlling your finances. And if you control your finances it gives you the second C, which is confidence that you are making the right financial decisions. And then that leads to the third C which is having the comfort in the peace of mind of knowing that you’re in great shape. So today we’re talking about required minimum distribution. So RMD stands for required minimum distributions. And so Zach, here’s a question for you. Do you know and this is fun because you’re not a certified financial planner. You do the marketing side here in the office and you helped me with radio these podcasts do you know which accounts required distributions apply to and which ones they don’t?  

Zach – They apply to all qualified retirement plans from my understanding 401(k)s, IRAs, 403(b)s you name it.  

Michael – Any exceptions, by the way you’re good doing you’re 99% correct but are there any exceptions?  

Zach – I mean all qualified funds from my understanding non-qualified maybe you don’t have to take RMDs or is it across the board?  

Michael – Well, here you go. So you were really, really close and there’s, the problem is, we’re talking about the tax code here and you know every time you talk about the tax code, what do we get? You know, we get here is the general rule but then they give you 14 different exceptions it seems like. But when you talk about required minimum distributions they apply to your first answer all qualified retirement plans is correct with one exception. That one exception are Roth IRAs. So what is, so let’s start with this. What is a qualified retirement plan? So let’s start there. And from there, we’ll then talk about how the required distribution system works. So what is a qualified retirement plan? Well, that’s gonna be anything under like a 401(k) or a 401(a), 403(b)s, 457 plans. So if you have a retirement plan that starts with a four then it’s a qualified retirement plan but what’s kind of interesting about this is, well what if you have a Roth 401(k)? So what if your 401(k) has both a regular like the traditional 401(k), but what if it also has a Roth provision in it? So what do you think Zach if your 401(k) is let’s say you have money in there and you have money, that’s both regular money and then Roth 401(k) money, do required distributions apply to both of those numbers or one of them, what do you think?  

Zach – They apply to both.  

Michael – They apply to both that’s correct. So Roth 401(k), Roth 403(b), Roth 457. All of those have Roth options if your company allows for that and they all still have what are called required distributions and this is, required distributions required minimum distributions or RMDs for short, they begin once you hit a certain age and when you have money and say a 401(k), 403(b), 457 or an IRA, a SEP IRA, a profit sharing plan, really any account that is essentially a type of account where when you save your money, it’s intended for retirement, but when you put your money in it is generally tax deductible the money grows tax deferred. When do you pay tax Zach?  

Zach – When you take the money out.  

Michael – When you take the money out at the end. Those types of accounts, those are called qualified retirement plans and those are the types of accounts that a required minimum distribution applies to. And let’s think about why this is. So let’s use a 401(k) as our example, you know, Zach we have a 401(k) here in our office that you contribute to we both do. Now let’s kinda go through the thinking here about why there’s such a thing as a required minimum distribution and then we’ll talk about how it works. So today, I mean you’re 26 I think, right?  

Zach – Coming up on 27 in a few weeks.  

Michael – There you go birthday’s coming up. I am only slightly older as far as we all know. And for both of us, we’re putting money into our 401(k). So now we’re using, I think both of us are using Roth contributions, but either way, we’re putting money into that account and the money’s growing like crazy. So let’s imagine that we’re using traditional 401(k). Let’s, don’t worry about the Roth now, traditional 401(k) we’re putting money in, we’re getting a tax deduction up front. We’re not paying any money and on how it grows and then we only pay money at the end, right? So that’s the situation you and I are in. Why would the IRS come to us at some point and say, “Oh Zach, Mike, guys, you gotta start taking money out of this thing. In fact, we’re gonna force you to start taking money out of this thing.” Why would they do that?  

Zach – They’re ready for us to pay tax on it. There they’ve given us our fair share for 40, 50 years. And they’re like, “Hey now it’s our turn to get a piece of the pie.”  

Michael – Yeah in other words, they wanna get paid, right? “They’re like, wait a minute we’ve been giving you all these tax deductions now it’s we gotta get paid.” And that’s why there are required distributions. The IRS wants to get paid at some point. They don’t want you to just continue to grow this money and you know never owe tax. So they created a system called the required minimum distribution system. And for the longest time, the way they did it, as they said “When you are 70 ½ years old. So once you’re at the age of 70 ½ that’s when you have to start taking money out of this thing.” And they have this table, right? They have a table where you, they actually show you. In fact, Zach I’ll send you the link and we can link that table to the to the comments on the show. But there’s what’s called a required minimum distribution table where essentially they tell you here is the percentage that you have to take out each year. And the older you get the higher the percentage. So the question really is 70 ½. So Zach, this is my question, why 70 ½ what’s up with that number.  

Zach – I don’t know why they selected and 70 ½ Is it based on life expectancy?  

Michael – Life expectancy you would think so, right? I mean that would make perfect sense. But here’s the problem. The problem is, and by the way what’s happening behind the scenes here, I’m trying to go to irs.gov and for some reason my computer doesn’t wanna connect to the internet right now, so that’s a lot of fun. See if I can do a Google? Yeah see Google’s working I wonder if the IRSs his website is down right now or something, but I’m pulling up the IRS minimum distribution table so we can maybe talk about it. The reason they picked age 70 ½ that’s what we’re talking about, right? The reason they picked eight 70 ½ is are you ready for it?  

Zach – I’m ready.  

Michael – Nobody knows. Nobody has any idea, right? We have no idea, it’s ridiculous right, nobody knows. And what happens here is that, you know it’s our government in action, but then what happened? What happened later on, right? What happened later on was in 2020 last year the government came out and they revamped the rules. This was, remember this is a big deal last year. And they said, we are they call it the SECURE Act And part of the SECURE Act was, are we gonna give you a break. Instead of waiting, you know instead of having to start taking distributions at 70 ½ we’re gonna back that up. Right, how far did they back it up?  

Zach – All the way to 72.  

Michael – Yes a whole year and a half. Yeah, now what didn’t they just make it 75? You know, why not make it kind of a round number? Who knows? But the rule today is this. When you hit age 72, that is a year that you have to start taking required distributions, right required distributions. And how much you say, “Well how much do I have to take out when I’m 72?” Well, it’s around 4%. Right around 4%, I think it’s a smidge less than that, but call it 4%. So if you have a million dollars in your 401(k) or your 403(b) or your IRA at the age of 72 you gotta take out 4% and that’s $40,000. And then guess what? Next year, when you’re 73, you gotta do it again. But the percentage goes up a little bit, maybe 4.2%. And then the next year you gotta do it again. And every year, as long for the rest of your life as long as you have money in these accounts you have to take out a required distribution. And the percentage of you have to take out increases a little bit each year. All right, Zach here we go. Let’s imagine you are stubborn. Okay, you are stubborn and you hate the IRS, right? I personally am not fond of the IRS. I don’t know that it goes as far as hate but let’s say you are stubborn and you hate the IRS. And you’re 72 years old or 73, whatever it is, and you’re forced to pull your money out but you’re stubborn and you say, “No way I don’t need this money. I don’t wanna take it out and pay tax on it. I’m not gonna do it. I’m not gonna take that money out because I don’t care what the IRS says. I’m not gonna listen to them. I’m not gonna take it out ’cause I don’t need the money, So why should I pay tax on money I don’t need.” So that’s what you do. What does the IRS have to say about that?  

Zach – They say, “Well, because you’re stubborn. We’re gonna penalize you for that. And it’s a big penalty.”  

Michael – It’s a whopping big penalty. How big of a penalty is it?  

Zach – 50%.  

Michael – I’m proud of you yes you get the price is right answer. You’ve just won the new car or something, right? Yes it’s 50, five, zero. But here’s the crazy thing. Let’s say that in our earlier example you’ve got a million dollars, you got to take out 40,000. Let’s say you don’t take that 40,000 out. So what’s the penalty?  

Zach – 50%.  

Michael – 50% right, of?  

Zach – $40,000.  

Michael – $40,000. Zach how much does that come up to?  

Zach – Another 20,000.  

Michael – Yeah, but now here’s the thing. You still have to take the 40,000 out. You still have to pay tax on all of it. And if you’re in the 25% tax bracket that’s 10 grand of tax. Then the IRS slaps another $20,000 of penalty on you. That’s 30,000 of tax on a $40,000 distribution, 75% tax. And at that point, Zach if that happens to you just one time are you gonna be stubborn again in the future?  

Zach – I would hope not.  

Michael – Yeah I mean, obviously not right. The IRS, the penalties are severe so you’ve gotta make sure you take out these required distributions. Now let’s go over a few areas where people mess this up. So we, I am oh, by the way I’m so sorry. Before I go to where we mess it up there, Zach we said earlier, this is the IRS in action. Do you think there might be exceptions to taking out required distributions?  

Zach – There might be a few but, it’s very specific.  

Michael – Yeah there are a few exceptions and primarily they fall in the area of what if you’re still working. What if you’re 74 years old, you’re still working at a company, you’re still contributing to your 401(k). As long as you are not more than a 5% owner of that company. So if you’re an owner, this doesn’t apply. But if you’re just a worker then you can delay taking any required distributions until you’re done working so that’s an example of an exception. There are a few exceptions but like you said, there aren’t many. So let’s talk about how do people really mess up their required distributions and how can you accidentally get yourself into trouble? So here’s some situations that we see happening all the time. Number one, this is a great story I’ll never forget about this. Several years ago, one of our clients asked us it was tax time and you know, we do tax returns for our clients. Several years ago one of our clients during tax time came to me and said, “Mike one of our really good friends, she just lost her husband. And you know, he always did the taxes for her. She’s just a mess, she doesn’t know what’s going on with the finances. Would you be willing to help her out with her taxes this year while she’s trying to kind of get her feet under her?” And I’m like, sure, of course I mean, it’s a friend of a client of course we’re gonna help. So let’s say it’s Margaret I just picked that name out of the blue. Margaret comes in, we’re doing her tax return and we said, “Hey Margaret can we get a copy of last year’s return? Just, you know we wanna make sure we don’t miss anything.” Of course so she gives it to us. And so we’re going through a tax return and we notice, we said, “Margaret, wait a minute. Last year’s tax return showed that you had a required distribution. We don’t see any documentation that says one was taken out you know, this year for this year’s tax return.” And she said, “Oh I’m sure it was done because my husband always did that.” So, okay well where’s the money. While he worked for general motors, it was in general motors 401(k), and they used Fidelity at the time. So we called up general motors 401(k) at Fidelity. We call it Fidelity and said, “Hey we’re trying to track the documentation for the required distribution that call him George took.” Well, George didn’t take a distribution. “What do you mean he didn’t take a distribution?” “Yeah our records show he didn’t take one last year.” Well, here’s what was going on with George, every year George would wait to the very end of the year to take his distribution a lot of people do that. They wait until December they wanna leave their money in there as long as possible to make money and that’s what he would do. And every December he would take the money out. But here’s the problem, George, after Thanksgiving dinner, wasn’t feeling very well. And then he went to the hospital and then he died in December never taking out. While he was in the hospital battling for his life at no point do you think, “Oh my goodness, I better hurry up and take out my required distribution before the year is over.” He was fighting for his life. His wife didn’t know, so guess what? No distribution. So we said, “Well how much is that distribution supposed to be?” Guess what Fidelity told us? $45,000, that was a penalty of $22,500. So by the way, this particular story has a good ending because it turned out our CPA had a friend in the IRS. You know, one of the guys that they are as it were there. And he, so he called up his friend at the IRS. He says, “Hey, let me tell you what’s happening here. Is there anything we can do to help this poor lady out?” And it turns out that in extenuating circumstances if you get an IRS agent who wakes up on the right side of the bed and you talk to him early in the morning, before his day goes to crap it turns out they have the authority to waive that penalty in extenuating circumstances. So he waived it for us thank goodness, big sigh of relief. But that’s a mistake that happens all the time. Another mistake that happens all the time, let’s say you retire you have money in an IRA. You have money in a 401(k) and your spouse has money in a 403(b). And you’re both over the age of 72 so you both have required distributions. Let’s say you both have IRAs and she has a 403(b) and the wife has a 403(b) and an IRA. The husband has a 401(k) and an IRA. In fact, let’s even make it more complicated, they’ve got two IRAs each. He has two IRAs and 401(k), she has two IRAs and a 403(b). How do you calculate your required distribution? Do you have to calculate a required distribution on each of those six accounts and pull out, you know out of each account, the requirement is that how it works? What do you think Zach?  

Zach – They think so.  

Michael – A lot of people, yeah, you could do that. And by the way, if you do that you don’t get into trouble. But here’s what happens a lot of people are like, “Oh no, I read somewhere you could aggregate accounts and just add them all up calculate your number and then pull the money from whichever account you want.” Is that true?  

Zach – No.  

Michael – The answer is maybe, here’s how it works. If your money is an IRA. So the husband and wife, they each have two IRAs. Each of them, they could add up their IRAs together, aggregate those separately and the husband could take his two IRAs add them up and say, “Oh, I’ve got a 100,000 in this one, 100,000 in that one, I’ll add them up that’s 200,000. Here’s my required distribution I’ll just pull it out from either IRA, you know whichever one I feel like.” He can do that that’s fine the IRS is happy with that but you can’t mix IRAs and 401(k)s or 403(b)s or 457s. Basically every category of qualified retirement plan you have and I believe, and some categories allow you to aggregate and some don’t right. It’s complicated as all get out. Here is a simple rule of thumb, here’s how to stay out of trouble this is my best advice. When you retire, don’t leave money in a 401(k) and don’t leave money in a 403(b) and don’t leave money in a 457, don’t do that. These tools, anything that starts with a four, right? If it starts with a four. They were designed to save money for retirement. They were never designed to leave money there after you retire. The intent was always you save your money in these plans while you’re working. But when you retire, the intent was you’re gonna roll this money to an IRA which is tax free. And you’re gonna have it in an IRA for the rest of your life. And why? Because in an IRA you can invest in anything you want. You can get professional advice if you want. You can, and it is the most flexible account to deal with required distributions. Because if all of your money’s in either one IRA or multiple IRAs, doesn’t matter, you can add them all up, aggregate them, calculate your required distribution and then you can withdraw that distribution from any of those accounts that you want. You know, some from all, all from one, all of it from a couple, whatever you want, don’t leave your money in 401(k)s, 403(b)s, 457s after you retire, whatever you do, don’t do that. And it’s a no brainer that if you have money in a Roth 401(k) a Roth 403(b) or Roth 457 remember you have to do a required distribution out of those. But what did we say at the beginning of this podcast today? We said Zach, there’s one exception. There’s one account that doesn’t have any required distributions at all. What is it?  

Zach – It’s a Roth IRA.  

Michael – Yeah take that Roth 401(k) when you retire, rolled into a Roth IRA, take that Roth 403(b) roll it to a Roth IRA. That Roth 457, roll it to a Roth IRA. If you do that, you’re always gonna stay out of trouble, right? So there you go required distributions. They happen when you hit 72 or older they happen on qualified accounts. And those are the rules, my friends. And we’ll go ahead and attach a link to this video that gives you both the worksheet to calculate them and the table that the IRS uses. All right.  

Zach – So Mike, if I’m someone who’s you know struggling with figuring out how to take my RMDs or how it factors into my planning, what do I need to do? What, who should I go to?  

Michael – Yeah, that’s a great question. You know what you can always call us. We’re happy to help. For those of you who are clients you know, we help you calculate them anyway. But if you just need a little bit of help, give us a shout. We’re happy to help you calculate them not a big deal for us. You know, it’s something we do all the time so it’s old hat. But here’s the deal you gotta take it out during the calendar year. If you are old enough where required distribution if it applies to you, you gotta take one out, you gotta do it during the calendar year. You cannot wait until when you file taxes to do it. Gotta be done during the calendar year, all right.  

Zach – Awesome sounds great any final thoughts before we sign off today?  

Michael – We’re good remember retirement should be the best time of your life. Make smart financial choices so that you can truly enjoy the best that is yet to come for you. Take care of everyone. 

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