Clients subject to required minimum distributions from retirement accounts were allowed to skip them last year, but RMDs resume in 2021. So, what strategies are on the table?
Going Steady
“We recommend using RMDs as a monthly supplement for Social Security,” says Jessica Hovis Smith, president of Longview Financial Advisors in Huntsville, Alabama. Account owners subject to RMDs are usually receiving Social Security, as age 70 is the last practical start date for those retirement benefits.
Monthly RMDs may be welcomed by clients who need income from their investments. “Part of this decision is psychological,” says Smith. “Setting up monthly RMDs and choosing tax withholding sets boundaries — some clients find it easier to stay within their means this way, versus a lump-sum RMD at the end of one year, which they are expected to manage for living expenses during the following year.”
Joey Stemmle, financial advisor with Riverstone Wealth Advisory Group in Midlothian, Virginia, a private wealth advisory practice of Ameriprise Financial, has clients who schedule RMDs each month to provide pension-like reliability.
“They may find it better, from a budgeting perspective, to receive their RMD two weeks before or after their Social Security check, essentially recreating a biweekly paycheck, similar to what they received while working,” says Stemmie, who is also a chartered retirement planning counselor.
Another potential benefit of monthly RMDs is that clients could receive a range of prices for any investments they sell. Stemmle, who is 2021 president of FPA NextGen, likens this process to dollar-cost averaging, with some assets sold at higher prices as well as lower ones, reducing the risk of an ill-timed solo sale.
“In addition to providing regular cash flow,” says Stemmle, “clients who take RMDs in monthly installments may retain some of the benefits of tax-deferred compounding in the account throughout the year.”
Lumping it, liking it
Clients who don’t need monthly RMDs may wait until December for a one-time withdrawal, thus keeping their complete accounts in tax-deferred territory for most of the year.
“We usually save this plan for those who do not need to supplement their retirement income,” says Smith. “Most clients in this situation react well to such a plan if the intent is explained. These clients tend to lean on us for tax planning, so they understand the benefits.”
Erika Safran, principal at Safran Wealth Advisors in New York, believes in one-time RMDs but prefers acting sooner than later. “Most of our clients’ RMDs are taken at the beginning of the year and moved to taxable accounts,” she says.
According to Safran, January-December tax deferral is “not a huge value” because any gain eventually will be withdrawn at ordinary income rates. Once money is in a taxable account, after an RMD, lower long-term capital gains rates will apply on any profitable sales one year or more later.
In terms of deciding which pocket to pick when drawing down an IRA for RMDs, a strategy for rebalancing is needed, according to Safran. At her firm, the typical strategy is to take a full RMD in January. “If clients need funds to supplement their lifestyle, up to two years’ expenses are set aside in cash equivalents,” Safran says. “The rest is rebalanced to meet planned portfolio allocation.”
Stock answers
Given that the broad stock market returned over 30% in 2019 and nearly 20% in 2020, rebalancing via RMDs may mean trimming stock positions held inside retirement accounts. Indeed, advisor Chris Cordoba, founder of California Retirement Advisors in El Segundo, California, suggests to some clients that they pay partial or complete RMDs in January, using stock market appreciation for the funds.
“We tell clients that if stocks continue to climb, increasing IRA values, they can use that appreciation for RMDs again next year,” Cordoba says. “If stocks drop, a buying opportunity might arise in the future.” In any case, he says, moving money from equities held in retirement accounts may help bring asset allocations into line and reduce exposure to a market pullback.
If asset allocation is not a key concern, RMDs might be done in-kind, according to Cordoba. Shares can move from an IRA to a taxable account, picking up a tax bill that’s due in any case while holding onto desired equities. Those shares would get a cost basis — the valuation on the distribution date — that could result in a modest tax bill or a deductible capital loss on a future sale.
“One of my clients, very interested in the idea of in-kind RMDs after strong results in 2020, is checking his cash resources to determine if he can afford to not sell shares from the stock position,” he says. “He’ll see if he can get by without taking any cash distributions for the year.”
Another cashless move is available to clients at least age 70 1/2: they can make qualified charitable distributions from their IRA, which can satisfy the RMD without generating taxable income. Interested donors should use qualified charitable distributions before other distributions because their first withdrawals from an IRA in 2021 will be treated as a taxable RMD unless they go directly to an eligible charity.