How to deal with required withdrawals from retirement accounts

Is there a recommended strategy for taking the necessary withdrawals from retirement savings in this terrible market? I am a buy and hold investor; normally i would just cower, not look at my balance sheets and ride out this storm. Unfortunately, the Internal Revenue Service is making me sell stocks at the worst possible time. Any recommendations for this unprofitable task?

These questions allow me to address several issues involving retirement accounts and required minimum distributions, or RMDs. Those withdrawals, of course, are part of the deal we make with the government when we open an IRA or similar account: We get decades (if we plan wisely) of tax-deferred growth, but we have to start using those savings — and paying taxes on the withdrawals – as we enter our 70s.

As it happens, the timing of these questions works well: Many retirees wait until the end of the year to withdraw needed funds from IRAs and the like. And before we get to the details, please know: the picture may not be as bleak as it seems.

A bear market does not change the size of your RMD. It’s important to start with this point: The fact that the markets are down this year does not mean that the RMD in 2022 will also be down. (As some retirees think.)

Remember: Required retirement account withdrawals in a calendar year are based on the previous year’s closing account balance. So, your 2022 RMD amount was set on December 31, 2021. This year’s drop in the markets (assuming your nest egg is invested in the markets) won’t change that.

However, the fact that the markets are down in 2022 – and the fact that your current savings account balance is likely lower than it was at the end of 2021 – means you’ll end up taking out more percentage of your nest egg to meet your RMD. Yes, that sounds painful. But consider:

The IRS does not “force” you to sell stocks. For starters, you can use cash in your IRA—if you have it—to satisfy your RMD, says Ed Slott, an IRA expert in Rockville Center, New York. It’s a really good idea to keep cash in your retirement account just for this purpose.

When asked how they use withdrawals from traditional IRAs, surveyed retired households* said:

But let’s say all of your IRA assets are invested in the markets. You don’t have to sell investments to meet the RMD; rather, the transaction may be done “in kind.” Mr. Slott offers the following example:

If your RMD is $10,000, you can roll over — and that’s the key word: roll over — $10,000 of XYZ stock from your IRA to a taxable brokerage account. This transfer counts toward your RMD. Yes, you will pay tax on the value of the stock (or mutual fund) on the date the assets leave your IRA. And that value becomes your new “cost basis” if and when you sell the shares now sitting in your taxable account.

Again, the point is: you haven’t “sold” anything – and certainly not at today’s low prices. You still own the assets; you just keep them outside of your IRA instead of inside.

(We should note here: RMD rules also apply to inherited IRAs.)

Is there a better/best time for this? Hard to say. Choosing the perfect time of year to take your RMD involves timing the markets, which is nearly impossible. As such, it helps to consider these decisions as part of your long-term tax planning.

Let’s say you take your RMD today, in early September 2022, and (again) move the withdrawal to a brokerage account outside the IRA. And let’s say the markets stage a significant rally next year. Naturally, you may regret missing out on earnings, earnings that would have been protected in your tax-deferred IRA.

Take a deep breath. Because the required withdrawal now resides in an account outside the IRA, “buy and hold” can work to your advantage, Mr. Slott says. For example, if you hold the assets for more than a year, any appreciation will be taxed favorably as long-term capital gains. In contrast, withdrawals from IRAs are taxed at ordinary income tax rates.

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And…if you hold the assets until you die, in most cases there will be no capital gains tax. This is because your heirs will receive an increase in basis. Again, conversely, IRAs don’t get an increase; when the account holder dies, the IRA beneficiary inherits the deceased owner’s basis without any adjustment.

Note: Congress suspended RMDs in 2020 due to Covid-19; this is highly unlikely to happen in 2022.

For many retirees, RMDs aren’t as big of a problem as they might seem. Yes, required withdrawals are upsetting for many. But when they’re put into perspective—when they’re lined up against your nest as a whole—they start to seem less disturbing.

As you probably know, RMDs are based on IRS life expectancy tables. At age 72, when withdrawals begin, only 3.65% needs to be withdrawn, Mr. Slott notes. At age 80, the figure is still only 4.95%. At age 90, it is 8.2%.

“For most people, say, age 80 or younger, the RMD amount — under 5% — shouldn’t be a big deal,” he says. “And if you can keep that amount in liquid investments in your IRA, you can just use those funds for your RMDs and you can leave your stocks alone.”

The IRS can do you a favor. Really. Again, no one likes to be forced to remove assets from their savings. But if you look at RMDs from a tax rate perspective, and you should, the required withdrawals may prove to be a benefit, at least for the next few years.

“Most people taking RMDs now are getting funds at historically low tax rates,” says Mr. Slott. “These funds cannot remain protected in an IRA forever. At some point they will have to be withdrawn and taxed in full. So you can also take them out when rates are low. And that may be right now for many.

Mr. Rufenach is a former reporter and editor for The Wall Street Journal. Ask Encore addresses financial questions for those thinking about, planning for, and living their retirement. Send questions and comments to [email protected].

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