With Christine Benz, Director of Personal Finance at Morningstar, and author of “Morningstar’s 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances”
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Christine Benz, Director of Personal Finance at Morningstar, is one of Steve’s favorite guests. According to Steve, most of us either have IRAs or 401ks that, as we retire, we may roll into IRAs, so the subject of the best ways to manage your IRA is an important one. He asked Christine to address the topic of RMDs—required minimum distributions for IRAs—and how to create a smart strategy for IRA withdrawals rather than just pulling the money out without any real plan. Christine is the author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances.
The Problem With Required Minimum Distributions
Steve and Christine have both had occasion to advise retirees who don’t care for the required minimum distributions they must take every year from their IRAs. The reason for their attitude is simple: RMDs can easily push you into a higher tax bracket.
One suggestion Christine offers for handling your required IRA withdrawals wisely is to examine your portfolio before deciding exactly where to take the money from. You may be able to combine your RMD with making a smart portfolio adjustment by selling specific investments that would be a good strategic move for your portfolio regardless of any IRA requirements.
For example, you may have some stocks that have appreciated in value to the point where they may not be likely to continue showing such stellar returns. Therefore, you may want to take profits on those, rebalancing your portfolio with other stocks that have more potential for the immediate future. Steve noted that people entering retirement may want to adjust their portfolio significantly anyway, shifting toward safer investments such as value stocks that offer solid dividends.
Plan Ahead To Avoid RMD Problems
Steve and Christine agree that it’s a good idea to plan ahead of reaching the required minimum distribution age of 70 and a half (Steve noted that passage of the Secure Act would help a little by raising the RMD age to 72). Rather than putting all your retirement savings into a 401(k) or traditional IRA, consider detouring a substantial amount into a Roth IRA, which allows you to take tax-free withdrawals during retirement. You may be able to save yourself a considerable sum during retirement by planning ahead with tax-diversified investments long before retirement.
What To Do With Excess Withdrawal Cash
There are many retirees required to take a minimum withdrawal of well over $100,000 when their annual living expenses are less than $80,000. Just because you have to take that money out doesn’t mean you can’t reap some financial benefits with it. You are, of course, free to put some of that money into a taxable investment account. Your financial advisor can help with setting up the most tax-efficient investments. Steve suggested looking at investing in some ETFs, which are very tax-efficient assets.
Christine is a big fan of putting some extra distribution money into your “cash bucket,” a cash account where you keep a couple of years’ worth of living expenses. Steve noted that if you deploy the money properly, in a high-interest savings account, for example, you can probably earn at least two percent and keep pace with inflation. Having a full two or three years’ worth of living expenses set aside—money that’s not at the mercy of the stock market—can give you some real peace of mind. And if there’s a significant drop in the market, you can feel smart for having kept all that money in the form of cash!
Using Qualified Charitable Distributions (QCD) As Part Of Your RMD
One of the best year-end IRA strategies is taking advantage of using qualified charitable distributions, QCD for short. You can take up to $100,000 of your RMD and give it to a qualified charity of your choice. That portion of your RMD which goes directly to the charity doesn’t count toward your adjusted gross income, so it not only helps the charity but also provides you with a major tax benefit. This move can be especially beneficial now that recent changes in the tax laws mean that fewer people are itemizing their deductions. QCDs give you a way to be charitable, get a tax break, and not have to fool around with figuring up deductions that might not be saving you much anyway. If you’re charitably inclined, definitely consider QCDs with your tax or financial advisor.
Part of your year-end actions with IRAs is a basic review of your overall investment portfolio, checking it not only for profits but also for diversification. One strategy that may help you out at tax time and also help you re-balance your portfolio is selling off some losing investments. Tax-loss sales can be used to offset gains you’ve realized, thereby reducing your total tax liability.
You can get more financial planning tips from Christine Benz at Morningstar!
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.
Steve Pomeranz: It is my pleasure to bring back a favorite guest of mine. Her name is Christine Benz and she is Morningstar’s director of personal finance, author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances, and The Morningstar Guide to Mutual Funds: Five-Star Strategies for Success. You all know Morningstar, and if you’ve been listening to the show, you know Christine Benz as well. Welcome back to the show, Christine.
Christine Benz: Steve, it’s my great pleasure to be here.
Steve Pomeranz: I want to talk about the IRA rules that people have to live by and also withdrawal strategies from your IRAs. I mean, most of us have 401ks that as you retire you roll into IRAs. Others have accumulated money in their IRAs and so on, so it’s an important subject for us to tackle. The topic really is about RMDs, which means required minimum distributions, and want to think about those retirement minimum distributions as a way of creating a strategy for withdrawal rather than just pulling the money out. Give us your thoughts on that.
Christine Benz: Right. I talk to so many retirees who are subject to required minimum distributions, which start at age 70 and a half, and the reason that retirees don’t love them, especially affluent retirees, is that they can push them into a higher tax bracket. Sometimes I’ll talk to retirees who say, “Well, these withdrawals are really more than I care to take from my portfolio.”
So a couple of pieces of advice on this front. One is that I think you can be surgical about where you go for those required minimum distributions. There’s nothing saying that you have to give each of the holdings in your portfolio a haircut to raise your RMDs. Instead, I think it’s a good strategy to periodically, once a year as you get ready to take your RMDs, take a look at your portfolio in totality and see if you can’t withdraw from those holdings that you’d want to adjust for a portfolio reason.
A great example right now is that we’ve seen strong outperformance with so-called large-cap growth stocks, so the well-known Apples and Googles and Netflixes. If you have them either directly or indirectly, maybe you have some mutual fund that’s focused on them, your portfolio, probably if you’ve been letting things ride, has gotten heavy on that stuff, so if you need to withdraw your required minimum distributions, take them from the appreciated part of your portfolio that’s potentially going to improve its risk-reward characteristics going forward.
Steve Pomeranz: Rebalance the portfolio. It’s not that these large-cap growth stocks are bad, but they generally are more risky in many, many ways.
Christine Benz: Right.
Steve Pomeranz: Growth rates, a lot of them are priced to project these spectacular growth rates, and if there’s any blip whatsoever, they tend to get crushed, and maybe it’s better as you get older anyway, to start thinking about kind of more of the stalwart kinds of companies that pay higher dividends, have cleaner bank balance sheets and diversified businesses, as well. So it’s kind of an easy way of thinking about getting more into—you mentioned growth stocks—getting more into value stocks, and bringing that portion of the portfolio up.
Christine Benz: That’s right. Potentially value stocks also, and I know it’s very hard to get enthused about bonds when you’re looking at 2% yields today, but I do think that for investors who have been hands-off with their portfolios, they may, in fact, want to add more to the safe side of the ledger. That might mean some cash holdings, that might mean some high-quality bonds because, while I don’t think anyone can predict when there will be some sort of an equity market shock, I think it’s reasonable, especially if you’re well into your retirement, to lay the groundwork in case some sort of a market downdraft does occur.
Steve Pomeranz: Yeah, I think you always want to, especially when you’re kind of on a fixed income or getting ready to be on one, you really want to take the road, the more conservative road, maybe the road less traveled. In this case, while everybody is hopping on the bandwagon for these really high-growth, sexy stocks, maybe it’s time for you to step back and go, “That’s not for me. Maybe if it was me, it was me as a younger person, but maybe not so much.”
There’s another aspect here that I want to discuss. I’ve seen so many times where really the vast majority of people’s savings were in IRAs. For a 401k, that’s the only place that they ever saved, so they end up with fairly large IRAs, and maybe their spending is $60,000 a year, but they’re forced to pull out 70 or $80,000 a year in these IRAs, and then as you get older, that amount actually increases, so I’ve seen cases where people are pulling out $150,000 from their IRAs and they’re living on 70 or $80,000, and that’s a tax burden that would have been relatively unnecessary had they diversified their savings and had more taxable savings as well. Have you seen that too?
Christine Benz: Absolutely, and that’s going to be true for more and more of us as people, baby boomers, get into retirement and they have most of their assets in tax-deferred accounts. Well, it felt good going in because you were in the tax break on those contributions, but money coming out is taxed at your ordinary-income tax rate, and as you said, Steve, as you get into the required minimum distribution zone of your life, that could push you into up into a higher tax bracket.
So for people who are still accumulating assets for retirement, that concept of tax diversification is so key. That can mean amassing assets in taxable accounts, as you said, where you can earn capital gains treatment on your withdrawals, or if you have Roth accounts available to you. Even if you’re in maybe a fairly high tax bracket at the time of the contribution, you really don’t know what will happen in retirement, especially if you’re someone who is accumulating a very large nest egg. You might be very grateful that you have paid taxes on some of your contributions in exchange for being able to take those tax-free withdrawals in retirement, which is what Roth accounts entitle you to.
Steve Pomeranz: There may be some good news on the horizon with regard to these required minimum distributions because the last time they changed the life expectancy tables was in 2002, and so now there’s a move afoot to update those life expectancy tables. This is the table that upon which the distributions are calculated, and because people are living longer, the amount of the distribution is expected to go down. I do have an example here for someone with a million-dollar IRA. The first year, they’re pulling out $36,500. That would go down to $34,400 under the new tables. So it’s not a lot of money, but it is some tax relief.
Christine Benz: It is, and another thing to keep on people’s radar is the fact that we have this Secure Act, which is wending its way through Congress. Looks like it has fairly good bipartisan support, which I know it’s hard to imagine, but it does appear to have some support in Congress, and that would allow the required minimum distribution age to lift from 70 and a half where it is currently to age 72, so RMDs would commence at age 72.
Steve Pomeranz: Right.
Christine Benz: So that’s another thing that people can maybe take heart in if retirement is still in their future. Another point I would make on the RMD front, Steve, is that if people have that high-class problem of having higher RMDs than they actually need to spend, and you referenced a case like that, you can reinvest the money back into your portfolio, so you can’t get it back into a traditional IRA, but you can at least get it into a taxable account, and there you can set up the account to be pretty tax-efficient going forward.
Steve Pomeranz: Yeah, true.
Christine Benz: You can invest in exchange-traded funds for the equity exposure, perhaps municipal bonds if you’re in a high tax bracket for the fixed income exposure, so it’s not a lost cause.
Steve Pomeranz: Right. I want to talk about that. So talking about I’m withdrawing this money, taking this money out, you want to think about how you’re deploying the assets. One thing you just mentioned was re-investing them and, in the meantime, getting the big picture of your portfolio—what is your allocation to stocks and bonds; the different categories like large-cap, mid, and small; some foreign companies; and the kind of the typical, generic overall asset allocation. But you can also fund your cash bucket for your living expenses for the next year.
Christine Benz: Right. I’m a huge believer in this bucket strategy. The basic idea is that you are setting aside maybe one to two year’s worth of cash needs in retirement and you’re holding that in cash. So you’re spending from that cash bucket on an ongoing basis. You’ve got to find a way to fill it up. Using your RMDs, I think can be a nice way to refill that cash bucket.
Steve Pomeranz: If you deploy the money properly, the cash money, you can get one and three quarters to two percent on some money markets now, so it’s not as if it’s earning nothing. Maybe it’s keeping pace with inflation at the very least, so actually investing in a longer-term bond isn’t really giving you all that much more right now.
Christine Benz: That’s right.
Steve Pomeranz: So keeping in cash really-
Christine Benz: Plus it can buy you some peace of mind, I think-
Steve Pomeranz: Exactly.
Christine Benz: … to know that you may have your near-term cash needs set aside. Your long-term assets will do what they’re going to do and they may be volatile at various points of time, but you know that you have your living expenses set aside. I think that can provide a lot of comfort in retirement.
Steve Pomeranz: I think when you’re retired and you’ve got some money in cash, there’s some frustration when the market’s rising, but when the market’s going down, you really, it really feels good. You really feel smart. Hey, I left some money in cash. And even if you’re not really using it, at least you know that if the market really gets hit hard, there’s some availability of liquidity for you to reinvest. You’re not a hundred percent-
Christine Benz: There’s so much-
Steve Pomeranz: Yeah. Go ahead.
Christine Benz: Right. There’s so much to be said for that kind of peace of mind.
Steve Pomeranz: Yeah.
Christine Benz: I think the key point, though, is that you don’t want to overdo it because there is an opportunity cost to having too much of your portfolio stuck in assets that have maybe a 2% return potential-
Steve Pomeranz: Yeah, absolutely.
Christine Benz: … in a good case scenario.
Steve Pomeranz: Let’s talk about some of the year-end strategies that people can use now. We’re in November, December, and December 31st is really literally right around the corner. First of all, when taking money out of your IRA, one thing you can do is if you have enough money and you are charitably inclined is to make a gift to a charity from your IRA. Tell us about that.
Christine Benz: Yeah, I love this strategy. This is called a qualified charitable distribution and this is something that people who are subject to RMDs can take advantage of. So if you’re pre-age 70 and a half, this isn’t an option for you; but if you’re post-age 70 and a half, you can take a look at this qualified charitable distribution or QCD. The basic idea is that you take a portion of your RMD or your whole RMD up to $100,000 and you steer it directly to a qualified charity of your choice. The beauty of the qualified charitable distribution is that that RMD amount that you sent directly to charity doesn’t count towards your adjusted gross income, so it lowers your adjusted gross income, which can be pretty beneficial come tax time, and it’s especially worthy of consideration because many fewer of us, due to the tax law changes that went into effect in 2018, are itemizing our deductions instead. The standard deduction is higher for many households.
Christine Benz: The beauty of the QCD is that it’s a way to be charitable, get a tax break, and not have to monkey around with deductions, which may not be saving you that much anyway, so it’s definitely something to investigate. You don’t need to send a whole hundred thousand dollars to charity. Even if you’re a smaller giver, it’s worth running the QCD through your RMD, so check with a tax advisor on whether this makes sense for you. For many people who are charitably inclined, this is a great strategy.
Steve Pomeranz: Well, if you give five or $10,000, I mean, it’s $1,200 in saved taxes or 2300 or 2,500 in saved taxes. I mean, that’s a considerable amount and every little bit helps and it all does add up.
Talking about things adding up, it’s time to start looking at your portfolio for tax-loss sales as well. Not everything in a portfolio, especially a diversified portfolio, goes up at once, and as I say sometimes, “If everything is going up at once, then your portfolio is not diversified.” That’s the definition, which means it’s not all going to go down at once as well. Stuff’s yinging and yanging all the time, so now it’s time to look for tax-loss sales.
Christine Benz: That’s right, and this might be especially fruitful for people who are individual equity investors. They may be able to find at least a few holdings here and there that are selling at prices below their purchase prices. There may be if you oddball categories in your portfolio, maybe commodities categories that really haven’t enjoyed great gains recently. So take a look. The virtue of looking for tax loss sale candidates in your taxable account is that you can use those losses to offset gains elsewhere in your portfolio, or if your losses exceed gains, which is unlikely except for maybe very unlucky investors today, you can use those losses to offset ordinary income. So it’s worth checking out.
Steve Pomeranz: Maybe you’ve taken a flyer and you’re just going to have to face it, you made a mistake or maybe you’re too early. Maybe you’re right. Maybe you’re going to be right, but you’re not right right now, so take your loss, wait 31 days, buy it back if you must, but that’s something to consider.
And finally, this has been a problem in the mutual fund industry for years, and I think 2019, to quote you, actually, “is going to be another doozy of a year” from a standpoint of mutual funds distributing their capital gains. We only have a minute left. Tell us about that.
Christine Benz: Yeah, I think it is going to be another bad distribution season. Active mutual funds have continued to see redemptions that forces managers to sell stuff. Many of these holdings are appreciated and, that in turn, can translate into a capital gains distribution that the fund pays out to you, the shareholder, so there’s not a lot you can do about this, unfortunately, but take a look. If it’s a holding that you wanted to lighten up on anyway, it may have been that you’ve already paid some of the taxes due. If a fund’s been a serial capital gains distributor, selling it might not unleash a big taxable gain to you, so you may consider selling preemptively before the fund makes its actual distribution. Get some tax advice here before deciding what to do.
Steve Pomeranz: Well, of course, yeah. And, of course, and as always, consider these ETFs which are very, very tax-efficient, have been from the very beginning, and I’ve been talking about them really from the very beginning, so that can save you taxes and help you manage your taxes as well.
Christine Benz is Morningstar’s director of personal finance and the author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances. Christine, thank you so much for joining me once again.
Christine Benz: Steve, thank you so much. It’s been great to be here.
Steve Pomeranz: And as you know, folks, my mission is always to educate my listeners, and I remind you week after week and segment after segment that we love to get your questions, so if you have any questions about your portfolio, your kids’ money, your kids’ kids, your retirement, any, your 401k, anything about taking better care of your family, give us a ring or email us and go to stevepomeranz.com, go to the contact section, and let me know how we can help. Also, you can hear our podcast, too. Over 640,000 shows have been downloaded, so find it on any podcast app or just say, Alexa, play The Steve Pomeranz Show. Now how cool is that? Christine, thanks again.
Christine Benz: Thank you, Steve.
Steve Pomeranz: All right, we’re out.
