Is it better to rip off a bandage and get the pain over with or to remove it slowly and gently, limiting the pain while prolonging it? That’s essentially the question facing seniors who have spent decades saving for retirement and now must take required minimum distributions in a down market.
Seniors who are 72 or older must take an RMD each year from their individual retirement accounts or a former employer’s 401(k) plan, and they can do so all at once or a little at a time. But with their account balances declining, it’s likely to hurt either way.
Those who wait until December to withdraw their annual RMD are taking a calculated risk that the market will recover from recent losses instead of giving up more ground. With the S&P 500 down about 12% this year, “it may make sense to continue to wait a bit” before taking an RMD, said Connor F. Spiro, senior financial consultant at John Hancock Advice. “Looking at past numbers, odds are you may be able to get some of that back by the deadline of Dec. 31.”
However, many seniors take RMDs early in the year because they need the money to pay expenses, they want to “check that box” for the year, as required, or they want to avoid potential investment losses throughout the year, Spiro added. And while that strategy may have been beneficial this year with stocks near record highs in early January, it costs seniors money over time since the market historically has had more good years than bad years, he said.
So, how best to manage RMDs during a downturn? Advisors say there are strategies seniors can use to minimize losses or manage distributions to allow a chance for markets to rebound. What’s more, there are ways to prudently maximize gains during a rally or in an up market and to minimize the need to sell securities into a down market.
Most seniors with IRAs or similar accounts can calculate their RMDs using the Internal Revenue Service’s Uniform Lifetime Table. A separate table, which can be found on the IRS’s RMD page, is used if the account’s sole beneficiary is the account holder’s spouse who is at least 10 years younger than the account holder.
A retiree turning 72 this year who had an IRA balance of $100,000 last Dec. 31 must take out an RMD of $3,650 for 2022, according to the IRS table. The RMD grows as the retiree gets older, so an 80-year-old with a $100,000 account balance would have to withdraw $4,950 this year. Failure to take an RMD results in a 50% tax on the amount not distributed as required. Those turning 72 this year can defer their initial RMD until April 1, 2023; they would have to take subsequent RMDs each year by Dec. 31, including a second one in 2023 for that year’s distribution.
Seniors concerned about further market declines should consider dividing their RMD by four or by 12 and then selling that amount of assets each quarter or each month, according to Steve Vernon, a consulting research scholar at the Stanford Center on Longevity.
Vernon, president of the retirement education firm Rest-of-Life Communications, said the idea is similar to dollar-cost averaging, where you buy shares at regular intervals, adding more when shares are beaten down and less when they’re climbing. “Basically, you’re just admitting, rightly so, that you don’t know what the market is going to do, so you’re going to mitigate your risk by averaging it throughout the year,” he said. “Trying to time the market usually doesn’t work very well.”
Retirees with cash on hand could consider transferring securities from their IRA to a brokerage account to satisfy their RMDs and avoid selling assets at a discount, said Dan Casey, founder of Bridgeriver Advisors. Seniors will be taxed based on the value of those securities at the time of the transfer, but the securities will have some time to rebound.
“You can just transfer the security right over without actually ever having to sell it,” Casey said. “As long as the value of that security satisfies the RMD, then you’re good. You just have to make sure you have the money set aside to pay the taxes.”
After taking this year’s RMD, seniors also should consider converting assets from a traditional IRA or 401(k) account into a Roth IRA, which allows investments to grow tax-free and has no RMDs. Retirees will have to pay taxes on the assets being moved into the Roth IRA, but with the market down sharply this year, that tax bill could be relatively low, Casey said.
However, seniors should be aware of the so-called five-year rule. Funds converted to a Roth IRA must remain in the account for at least that long to avoid a 10% penalty for early withdrawal.
Building a Cash Buffer
Since a diversified portfolio should include some cash, seniors ideally should be able to take an RMD without selling assets in a down market, Vernon said. One way to build up cash is to have dividends and capital gains distributions from equities such as stocks and mutual funds paid in cash instead of having that money automatically reinvested, he said.
Balanced funds, which include a mix of stocks, bonds, and other securities, provide an effective way to do that, said Peter Casciotta, owner of Asset Management & Advisory Services of Lee County in Florida.
He points to three mutual funds from American Funds—
Income Fund of America
American Balanced Fund
Capital Income Builde
r (CAIBX)—as a way retirees can build a “defensive equity portfolio.” Balanced funds typically experience less pricing volatility than mutual funds composed only of stocks, and they provide a reliable stream of cash, even in a down market, Casciotta said.
“I’ve got my older clients in them because they can still earn good returns and they don’t have crazy volatility at all,” he said. “I call it a little bit of plain vanilla.”
If seniors must sell securities to cover an RMD, they should consider selling one or more of their best-performing assets at opportune times throughout the year, such as after a stock beats earnings expectations, Casciotta said. Despite the recent market downturn, long-term investors should still have some assets that have performed well over time, and selling those gives other assets time to recover, he said.
“You have all year to take out your distribution, so there may be some times where you can hand-pick the investment that you’re going to be taking your distribution from because at that moment in time, the economics are good,” Casciotta said.
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