Distributions from your retirement accounts are not required by the IRS for 2009. But does that mean that they aren’t necessary?
Congress determined the 2009 waiver of Required Minimum Distributions as a way for retirees to shore up their retirement savings by keeping them invested rather than liquidating at depressed prices. This makes sense except for a few minor details like making sure that bills are paid and having food on the table. Many folks simply aren’t in the position to afford doing without their distributions from pre-tax retirement accounts. For those who have other sources of cash flow, this waiver does present opportunities for tax planning purposes.
One of the things we tend to focus on during the tax planning process is the marginal tax rate; or, the rate at which the last and next dollar of taxable income will be taxed. A common example of how the marginal rate can be especially severe for retirees is in the area of Social Security benefits.
Social Security Tax Liability
The tax code allows that below certain income limits Social Security benefits are not subject to income tax. However, once those limits are exceeded a percentage of Social Security benefits must be added to the taxable calculation. This inclusion of Social Security benefits can effectively create a hidden, higher marginal tax rate. An opportunity that the waiver of RMD presents is in managing the amount of income so that the addition of Social Security benefits is mitigated.
Tax Planning Over Multiple Years
Tax planning often requires looking at multiple tax years in order to reduce the overall tax effect. Care must be taken so that the efforts related to an earlier tax year are not undone by future cash flow needs that push subsequent tax years into unintended marginal tax rates. If, for instance, a large expenditure (i.e. new car, medical costs, etc.) is looming on the horizon it may make sense to take a 2009 IRA distribution – even though it is not required – if it allows you to stay away from a higher tax bracket in 2010. There can be many complicating variables involved in the multi-year analysis, including itemized deductions and the alternative minimum tax to name just a few. However, the cumulative tax savings can certainly make it a worthwhile exercise.
Required Minimum Distributions are not eligible for Roth conversions so the 2009 RMD waiver provides an opportunity for those taxpayers whose adjusted gross income (not counting the amount converted) does not exceed $100,000. The benefit of a Roth is that its earnings grow tax-free and the assets of the account will not be subject to required minimum distributions during your lifetime. There will be taxes due on the amount that is converted, however, so it is important to pay close attention to the projected marginal tax rate during the tax planning process.
Tax planning is an often overlooked and underutilized part of the annual cycle of tax compliance. Too often folks miss out by waiting until after December 31 to start looking at their tax situation. By then it’s often too late. The RMD waiver is another opportunity for some taxpayers to get it right.
Please contact us with questions regarding your investment accounts and to ask what the new RMD wavier means for your personal situation.
