Good to Know

Savvy financial advisors know that prudence in taking retirement distributions is balancing income tax efficiency in the current year against long-term retirement portfolio growth.

While each client may present unique needs, a discussion starter to the question “where should I take my distributions from?” follows:

First – Take the full amount of IRS-required minimum distributions (RMDs). No exceptions. Do this first! Why? Your client faces a 50% under-distribution penalty for getting this one wrong.

For example, if your client’s RMD is $35,000 and he takes only $20,000, he will incur a $7,500 under-distribution penalty (50% of the under-distribution). And btw, he’ll still have to take the rest of the RMD and the $7,500 penalty is not deductible.

Second – Take distributions from taxable (not tax-deferred) accounts up to the next income tax rate bracket.

For example, assume your client is nearing the 24% marginal income tax bracket. A taxable distribution greater than $5,000 would be taxed at 24% to the extent it exceeds $5,000. Tax-efficiency suggests a maximum distribution of only $5,000.

Third – Take qualifying distributions from tax-exempt Roth accounts.

This tax planning flexibility in retirement underscores the need to have at least some of the retirement portfolio invested in Roth IRAs or Designated Roth Accounts in employer-sponsored retirement plans.

A qualifying Roth distribution of tax-free earnings is one in which the account has been open and funded for 5 years and:

  • The account owner is age 59½,
  • Deceased (inherited Roth), or
  • Disabled.
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A financial advisor’s role should be focused upon helping a client understand the key steps in choosing a tax- and portfolio- efficient distribution strategy.

Generally, an advisor should not recommend a specific distribution strategry unless the advisor is an experienced tax planning proferssional acting with the approval of the firm's compliance. department.

Disclaimer

The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide financial advice to clients. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.