Tom Shows Us How RMDs are Calculated
Transcript:
Katie Nealis:
So as you mentioned, someone last week asked us to dive a little deeper into how required minimum distributions are calculated, and how much taxable income they may expect.
Tom Vaughan:
Okay, so requirement of distributions, also known as rmds, are really a critical component of retirement. And I get asked about all the time, and I’m not surprised last week, we did a little piece on, you know, some of the factors that go into requirement and distribution, some of the things that we think are important. And it’s one of the things we deal with constantly. And then this week, somebody wanted to follow up, you know, more in depth basically, and how the calculation happens and what have you, you know, how much taxes could they expect to come out and those types of things. So, very, very fascinating area, because you know, that if you mess up the calculation, the penalties, pretty severe, it’s a 50% penalty. If you’re supposed to take out 20,000, and you didn t know, then you’re going to get hit with a $10,000 penalty, which nobody wants. So this is why everybody’s asking. So let me just quickly, I’ll share my screen and essentially, share, you know you with how this might work. All right, give me an example. So very simply, I don’t like to use a lot of words in my, you know, presentation here, but this is probably necessary. This is how it’s calculated. They take the balance for the end of the year for your retirement accounts, and they divide it by this life expectancy calculator to get your RMD. And so again, if you’re looking at, hey, I turned 72, this year, I would look at last year, the very last day, how much did I have in my retirement accounts. And I would divide that by the life, the life expectancy factor. So this factor comes from a table, which is right here.
Again, a lot of small print here, but I just try to get the overall theme, which is just, you look up your age. So again, let’s say you’re turning 72, this year, you find this factor 25.6. Okay, so we would take that and get back to this again, and let’s just say you have a million dollars in your retirement plans, you’re going to divide that by 25.6. And that’s going to equal $39,062.50, you have to take out at least that you can take out more, that’s not an issue, you can’t take out less, because again, anything lower than that, they’re going to charge you a 50% penalty for missing that. So somewhat important to get that right. One of the things we work on with our clients all the time to make sure that we got the requirement of distributions, right. There’s all kinds of ramifications here, because this is taxable income that’s coming out onto your tax return, whether you want it or not. And so there’s you know, some strategies there. But in essence, that’s, that’s an important component of what you’ve got to do. And so if we go back, just some quick comments about this table that are interesting, because questions I get all the time. Number one is, you know, how much taxable income Am I going to get. So I’ll show you an example here in just a moment for that for that million dollar case. But look at this, what happens is, every number is getting smaller, so at 73 is 24.7. At 74, it’s 23.8. If you divide by a smaller number, you’re taking out a higher percentage every year of that account. So that’s important.
So higher percentage every single year will come out of your account. Now, the other thing that’s important to understand is that if you because other people ask, will I run out of money in my IRA or the income stop, if you just take out the minimum distribution and follow this table, you will not run out of money in that account. Now your income may go down or up depending on what happens to the value of your account. But if you look here at 115, they’re still dividing by 1.9. And so tell you divide by one, when you divide by one, that’s 100%, that means all of it comes out, you still have money in that account. So you would have money until in this particular case, at least 115 years old, if you just follow the minimum. So it’s a way to kind of create a pension in a way out of that. Again, it does fluctuate depending on the value of the account. And so I’ll show you what this would look like. So we’ve taken this million dollar case. And here, you remember the 39,000 that we had to take out, right, let’s just assume that it’s in a 60% stock and 40% bond portfolio. And we’ll use the average rates of return for that. Now, life is not a straight line, the market goes up and down. You would never see this, you know come out this smoothly, because the account values are going over. But over a period of time you should be gaining something in this account. Plus you have to take out a higher percentage every year because that factor is getting to be smaller. And so you can see what happens here.
You know, this continues to grow all the way up until you know maybe 145,000 100 $50,000 here, and then it finally starts to turn down. Now this is all the way out to age 100. And what that means is when it turns down, it means that the amount has exceeded the value of the account and exceeded the growth and the value of the account. So next, I’ll show you the account. This is what the account looks like, lots of people asked me what I still have money left? Well, it depends on your rate of return. But if you had the average rate of return for a 60%, stock portfolio, 40% bond, your account would theoretically grow under this all the way from a million to 1.4 million, and then eventually come back down all the way, you know, to age 100, where it’s about, you know, 900,000. So still, you know, some money is in there for your beneficiaries, if that matters to you, as far as that goes. So, in essence, that’s, that’s how it works. And this table is the factor that we look at in terms of trying to figure out, you know, what, what you take out what is happening in terms of the overall piece, and there’s a whole bunch of tax planning pieces that come around this particular aspect of your retirement, it’s a really important point is why I get asked about it all the time.
Easan Arulanantham:
Yeah, it’ll be interesting, because next year, they’re updating the table. So I think for Sony, it’ll be around 20.6, I think 9.6. And so it seems like they’re pushing out, as we live longer and changing with the demographic.
Tom Vaughan:
Yeah, what he’s talking about is right. So right now at age 70, the top of this chart here is 27.4. If they move that to 29.6, all of these numbers will move up. And what they’re doing is trying to account for life expectancy increase. And that’s a good thing, because that means that you’ll be forced to take out less, and will even last longer. And so again, this is something we can revisit, you know, again next year after they change that, but it’s a it’s a it’s a that’s an important component of what’s going on there.
Yeah, so, um, in the chart that you were just showing the minimum distributions just keep growing and maybe more than someone needs. Is there a way to lower them?
Yeah, that’s a good point. In fact, I get that a lot. I mean, if you look at that chart, in general, you know, go back to it real quickly here. You know, here’s the projected income that might come out on an even rate of return, you know, there’s somebody who’s in their 90s, do they really need $140,000 worth of income at that point in time, and that’s the big problem. That’s why I call this a tax time mom, for those people that have large amounts of money in retirement accounts, you really need to do some planning, the window that we look at, for really heavy planning is 15 years before retirement and 15 years after, and in that 30 year windows, when you can really do a lot of different things. And so, as soon as possible, you want to be able to take a look at the opportunity to convert some of these retirement plans into Roth IRAs doesn’t work for everybody.
But when it does work, it can work quite well. And what that does do is lower the potential tax, that you have to pay long term on this retirement accounts. Because a Roth IRA grows tax free, and you don’t have to take it out, there is no requirement of distribution for a Roth. So that just gives you a really powerful scenario where you can let it grow grow tax free. So yeah, that’s a good point. Katie, actually, I think one of the things that super important about, you know, looking at what’s going on with requirement of distribution is really about that planning around that. It’s a huge piece of tax planning that we do. And honestly, from what I’ve seen, and not many people are ready for this. They really haven’t thought about it. They don’t know enough about how it works. And you know, they’re going along and don’t realize what’s facing them.
One advantage for us in our type of business is, you know, I’m meeting with hundreds of households every six months, and I’ve been able to see, oh, boy, these people are having to pull a tremendous amount of money. It’s a huge tax problem. It’s increasing their Medicare costs, this is a huge issue to deal with. And so I you know, I’ve already gone down this path with so many clients, you know, I can start with somebody, you know, I mean, that’s why I converted my IRAs and 401k already, even at my age to Roth, just because I can see the future there. And I don’t want this tax time on, you know, and so, almost no matter what age you are, you can start to work on that and even use some of your required minimum distribution, income, to pay some of the taxes to do a Roth conversion for that year. portion of your account so you can just keep moving over and that’s a whole other subject altogether. But it’s still a piece of the puzzle here required distributions are huge.