By Eric Reich
Last week we discussed some of the pitfalls in retirement planning. This week, I wanted to continue that discussion with a pitfall so big that it warrants its own article. There is currently about $45 trillion dollars sitting in retirement plans and IRAs. That’s a number that is difficult to fathom and great news for all the savers out there. The problem that is growing by the day is that 73% of retirees currently wait to take money out of those accounts until they are forced to begin withdrawals through Required Minimum Distributions (RMDs). Of the 73% that wait, 71% take as little as possible from RMDs and are taxed as ordinary income unlike non-retirement investments held for more than 12 months which are taxed as long-term capital gains which can be at a lower tax rate (though not always).
On the surface, taking only RMDs may seem like a good idea. If you don’t need the money, and it isn’t taxed favorably, then why would I want to take out more than I have to? Well for starters, the minimum amount you need to take out grows not only as your account values grow but also as a function of your age. The RMDs you take from your retirement accounts are based on the IRS’ uniform life expectancy table. As you get older the percentage that you are required to take out grows. If you don’t want to take out your required distribution when your RMDs start, you really won’t want to take them out after a decade of account growth at a higher percentage. This is why there is so much money sitting in these plans. They keep growing, and nobody wants to take the money out and pay the tax.
We as advisors must begin to address this growing problem. I know this is going to sound unpopular and probably make my CPA friends cringe but taking money out of IRAs sooner than required and paying tax at a known and historically low tax rate, is almost certainly better than waiting to pay it later when the amount is much larger, and the tax rate is unknown, and I would argue likely higher. Even if tax rates aren’t higher, taking less money out at the same tax rate is better than taking it out when the account doubles or triples in size. Doing that may push you into a much higher tax bracket.
Nobody wants to pay taxes. I get that. We don’t know what tax rates will be in the future. I understand that too. What I do know is that as a country, we are almost $36 trillion dollars in debt. That number is growing rapidly. Do you really believe that we are going to see tax rates go down in the next 20 years? Even if for some unimaginable reason they did come down ever so slightly, the total tax you would pay on money withdrawn from that account based on a much larger account value would likely eclipse any possible (and extremely unlikely) tax savings. Don’t look at it as the tax I pay today vs. tomorrow, look at it as the total amount of tax I will pay on that money in my lifetime, or the lifetime of my heirs. To me the total tax paid (even adjusted for net present value) is all that matters. If I’m only taking RMDs, then I obviously want to pay as little tax as possible. If that’s true, then waiting to take out all of the money you are required to take, and your heirs are required to take will almost certainly result in paying more net taxes than if you start to draw down those accounts now.
Don’t make the mistake that many people make, which is believing that taking the minimum required amount will save you taxes, it probably won’t in the long run.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.
Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement. He is a Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations.
