Required Minimum Distributions and Roth Conversions
We have already covered our approach to using dividends and income primarily when taking RMD distributions. Our goal is to make sure most of what clients take out is dividends and interest. Further can be said about that topic. This is more tax law than investment practice, but as you will see later, these two are related and that is why the concept of “Financial Planning” is overdone in those over, say, 50.
Two ways people take money out of an IRA when they simply don’t need the money.
Frequently I run into situations were taking money out of one’s IRA at age 72 is a burden for the client. They are in a position where they don’t need the money, and don’t want the taxation. A couple of ideas should be evaluated.
Do your Charitable Contributions from you IRA
If they don’t need the money and they are charitably minded, the tax code right now offers the option of giving the money directly to a charity and not paying taxes on it. This could be one or several charities and it doesn’t have to be the entire RMD.75
Give your heirs the gift of no taxes on your IRA.
The other idea is used less often. It involves what might be described as “tax arbitrage” between the generations.
Steve is a widower. The highlight of his week is going out and playing golf with his grandsons. These boys are the beneficiaries to his IRAs. He has plenty of after-tax money in his living trust. He doesn’t need a nickel of his IRAs; he is simply forced to take it by tax law.
Steve’s effective tax rate is about 10%.
We posed the idea to Steve that, by the time he “is in a position to not care about his money” his grandkids will be in their top earning years and will likely have a marginal tax bracket north of 25%. As his IRA beneficiaries take money out of his IRA after he has passed, it will likely goose their tax rate even higher.76
Why not instead Convert your IRA to a Roth IRA, now, Steve? It will be approaching tax neutral for you, sure, you will go from 10% to say 15% that year on your tax rate, but it will really help the boys.
First, they will never be forced to take money out of the Roth Conversion IRA we set up for them. And second, when they do choose to take it out, the distributions will not be taxed! If they want an upgrade their house or to put their kids through school, the money from grandpa was taxed at his level many years ago.
This is the beauty of a Roth Conversion and it doesn’t apply jut to Grandpa Steve, it applies to others. This year I will be able to control my taxable income and I will likely take some portion of my IRA and convert it to a Roth.
