Happy 70th birth­day. Now start draw­ing down that IRA

Manda­tory pay­outs from sav­ings plans may trig­ger new taxes “Once you hit 70½, you’re re­ally out of the sweet spot”

Bloomberg Businessweek (Asia) - - CONTENTS - −Lewis Bra­ham

About 75 mil­lion baby boomers be­gan turn­ing 70 this year. If you’re among them, there are crit­i­cal de­ci­sions to make about your re­tire­ment ac­counts and fi­nances in gen­eral.

Why is 70 the magic num­ber? U.S. tax law stip­u­lates that you must take your first re­quired min­i­mum dis­tri­bu­tion (RMD) from your in­di­vid­ual re­tire­ment ac­count and 401(k) ac­counts in the year you turn 70 ½ (or up to April 1 of the fol­low­ing year) and pay in­come taxes on it. Those who don’t com­ply face a 50 per­cent penalty on that amount. “This is a ma­jor shift if you’re a boomer,” says re­tire­ment ad­viser Ed Slott, founder of IRAHelp.com. “All this time you’ve been taught to build, save, in­vest, sac­ri­fice. Sud­denly the govern­ment at age 70 ½ says, ‘Now we’re sick and tired of wait­ing for you to drop dead. We want our money back.’”

The scale of dis­tri­bu­tions for boomers, who were born be­tween 1946 and 1964, will put fi­nan­cial ad­vis­ers in uncharted ter­ri­tory. “This year is the largest pop­u­la­tion of first-timers tak­ing their min­i­mum dis­tri­bu­tions we’ve ever seen,” says Maura Cas­sidy, di­rec­tor for re­tire­ment prod­ucts at Fi­delity In­vest­ments. “That’s over 90,000 clients. With­draw­ing is a new con­cept for th­ese peo­ple, and we want to make sure they do it right, be­cause of the 50 per­cent penalty.” She says the av­er­age IRA bal­ance for its 70-year-old clients is about $200,000.

The IRS has a work­sheet to help you de­ter­mine how much to with­draw each year. The RMD in 2016 starts at 3.6 per­cent of the yearend bal­ance on your tax-de­ferred re­tire­ment ac­counts and grows each year: By age 80 you’re tak­ing out 5.3 per­cent, and by age 90, 7.9 per­cent. Al­though the 50 per­cent penalty on missed or un­der­size with­drawals is steep, tax fil­ers can ask the IRS to waive it. “File Form 5329 with your tax re­turn and say you missed it be­cause you were con­fused or had poor fi­nan­cial ad­vice,” Slott says.

Man­ag­ing your RMDs isn’t the only fi­nan­cial chal­lenge await­ing those who turn 70. That’s also the age when an in­di­vid­ual can be­gin col­lect­ing the max­i­mum ben­e­fit for So­cial Se­cu­rity. Those who opt to re­ceive ben­e­fits at the ear­li­est age of 62 re­ceive about 25 per­cent less per month than a 66-year-old re­tiree and 43 per­cent less than a 70-year-old one. Boomers who have the fi­nan­cial where­withal should def­i­nitely hold off un­til 70.

Still, de­lay­ing the pay­outs can raise

thorny tax is­sues. “Once you hit 70 ½, you’re re­ally out of the sweet spot of tax plan­ning, be­cause you’re forced to take dis­tri­bu­tions and So­cial Se­cu­rity,” says Bob Mor­ri­son, a fi­nan­cial plan­ner at Down­ing Street Wealth Man­age­ment near Den­ver. Re­ceiv­ing too much money at once can knock you into a higher in­come tax bracket or de­prive you of de­duc­tions. “Once your in­come ex­ceeds $250,000, the IRS phases out your per­sonal ex­emp­tions—$4,000 per in­di­vid­ual—and then at about $300,000 your item­ized de­duc­tions start phas­ing out,” he says. Those could in­clude de­duc­tions for med­i­cal ex­penses and mort­gage pay­ments.

For this rea­son, Mor­ri­son rec­om­mends that clients start con­vert­ing a por­tion of their tra­di­tional IRAs into Roth IRAs be­fore age 70. Roth IRAs not only of­fer tax-free with­drawals but also have no RMDs. The IRS even lets you add money to a Roth ac­count as long as you’re still work­ing past 70. Roth con­ver­sions are tax­able events them­selves, but one could con­vert just enough each year prior to reach­ing 70 to keep from be­ing bumped into a higher bracket. Even this strat­egy has wrinkles, de­pend­ing on where you live and where you plan to re­tire. “If you live in New York City and have a high in­come, you’re prob­a­bly pay­ing very high state and lo­cal in­come taxes,” says Matthew Kenigsberg, vice pres­i­dent for fi­nan­cial so­lu­tions at Fi­delity Strate­gic Ad­vis­ers. “But Florida has no in­come tax. So if you’re plan­ning to re­tire there, it would make sense to wait till you’re in Florida to con­vert to a Roth to avoid pay­ing those lo­cal New York taxes on the con­ver­sion.” On the flip side, some­one liv­ing in a no-in­cometax state like New Hamp­shire who plans to re­tire in a high-tax one such as Cal­i­for­nia should con­vert to a Roth early to avoid the fu­ture tax­a­tion.

Per­haps the big­gest de­ci­sion many boomers will face upon reach­ing 70 is whether to re­tire. Steven Pod­nos, a fi­nan­cial plan­ner with Wealth Care in Co­coa Beach, Fla., of­ten coun­sels clients to keep work­ing at least part time for psy­cho­log­i­cal rea­sons, “be­cause they have some anx­i­ety over liv­ing off a pool of money,” he says. “We see that a lot.”

For the most dili­gent savers the psy­cho­log­i­cal trauma of spend­ing down as­sets may be the great­est chal­lenge. “They’ve worked so hard to build their port­fo­lio, they’re hes­i­tant to take any­thing from it,” says fi­nan­cial plan­ner Bron­wyn Shone of BlueSky Wealth Ad­vi­sors in Pleasan­ton, Calif. “In one case, I had to give clients per­mis­sion to buy ten­nis rack­ets and hik­ing boots. ‘Please go buy them,’ I said. ‘You can def­i­nitely af­ford it.’”

The bot­tom line Baby boomers start turn­ing 70 this year—and they have to be­gin with­draw­ing from re­tire­ment ac­counts or face penal­ties.

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