Sign up with your email address to be the first to know about new products, VIP offers, blog features & more.

You are viewing Rule of Thumb

What to do if you forgot your RMD

While there are a couple of exceptions, you’re required to take distributions from an IRA or a 401k under two circumstances. These are known as the Required Minimum Distributions, or “RMDs”, and they generally apply to:

a. Your own IRA, in the year you’ve reached age 70-1/2; and

b. An IRA you inherited, from someone other than your spouse, in the year following that person’s death.

Failure to take the RMD results in one of the most severe penalties you can imagine: the penalty is 50% of the missed distribution amount. So if your IRA is worth $100,000, and the RMD calculation is, say, $4500, the penalty for not taking that distribution is $2250. Ouch!

Luckily that penalty can be waived if you have a good excuse and you correct your oversight. The details are in the IRS guide to IRAs, Publication 590. But Boston area attorney Natalie Choate, a specialist in retirement distribution planning, summarized the process for me when I attended a seminar sponsored by the Boston Tax Institute a couple of weeks ago.

It appears that the IRS will generally waive the penalty when there is both a “reasonable cause” and “remedial action”. Reasonable cause can be an error by the IRA custodian, or bad advice from an advisor, or your illness, military service, or, surprisingly, your incarceration! The remedial action is usually your making up for the distributions that you had previously missed.

You also have to file IRS Form 5329 as follows:

·On line 50, enter the amount of the RMD that you missed

·On line 51, enter the amount of the RMD that you took, usually $0

·On line 52, enter the difference as $0, and mark “RC” in the margin to indicate “reasonable cause”

·Attach a statement on the “reasonable cause”, and provide evidence of the remedy or corrective action.

Form 5329 can be filed as a stand-alone form for the tax year in question, and no amendment of your prior return is needed.

If you find yourself in this situation, you should contact a tax accountant to guide you through the process.

If you have specific questions about your RMDs, please email me at ron@ol-advisors.com

 

Our Take on the “4% Rule” for Retirement Withdrawal

Many advisors tell their clients, as a rule of thumb, a client can withdraw about 4% of their portfolio each year, without it affecting the principal. We have been telling our clients this for years. In fact, this rule of thumb dates back a few decades and was determined after a lot of research.

And then a few weeks ago, an article written in the WSJ called into question the validity of the rule of thumb. Its premise is quite simple: if you retire and then your portfolio drops like it did in 2008, then a withdrawal rate of 4% of the original balance would most likely not be able to sustain you through retirement. You would then need to reduce your withdrawal rate. In the investment and financial community, this was quite a statement to make and has caused many individuals to question their current withdrawal rate.

It’s important to consider a few points that the article touches upon, but are overlooked:

1) The “4% Rule” is a rule of thumb, a guide, a rough figure to help investors determine how much they can withdraw from their portfolio in retirement.

2) A client should only take what they need from their portfolios. They should keep as much invested as possible, so their assets can continue to appreciate. An extra $1,000 sitting in a checking account earning next to nothing, should probably stay in invested where it can generate a decent return.

3) The “4% Rule” does account for some of the long tail risks. When this rule of thumb was calculated in the 90’s, it did use data points going back to the depression. Of course, there are scenarios where the “4% Rule” will not work, but these are the outlier scenarios. They are economic situations that happen every 75 years or so. Fortunately, we are recovering from one of them right now.

The most important point to take away from this post and the article is to remember that the “4% Rule” should be renamed “4% Rule of Thumb”. Maybe then investors will understand that withdrawals will have to fluctuate depending on market conditions and their needs.

If you’re interested in some additional information on this topic, Vanguard has a few interesting pieces on the topic.

 

Why Is It So Hard to Make a Tax Deductible Contribution to a Traditional IRA?

During tax season, we had dozens of conversation with clients that begin with the client asking, “can I make a tax deductible contribution to my IRA, so I can lower my tax bill?”

Unfortunately, the answer isn’t a straightforward “yes” or “no”. Rather, we have to drill into each client’s specific situation to make sure we follow the in’s and out’s associated with IRA contributions on a case by case basis. The below infographic does a pretty good job at capturing the complexity of answering the question. Bottom line, before making a contribution to your IRA, consult with a financial advisor or tax professional because it’s complicated.

IRA Contribution Flow Chart

Five strategies to fix the biggest problem with your portfolio

The single greatest factor to affect your financial goals for retirement has nothing to do with investment options, asset allocations, bonds or stocks. Rather, it’s the amount you save for retirement year over year. And yet, many struggle to save for retirement despite the facts. Business Insider recently published an excellent article that detailed some of the reasons why individuals are not saving enough for retirement.

So now you know why you aren’t saving enough, here are a few top strategies you can use to improve how you save for retirement:

1) Aim to save about 10% of your gross pay for retirement. It’s a rule of thumb – if you’re starting to save later in life, that rate will have to be higher.

2) Double check that you are taking advantage of matching programs with your employer’s 401k.

3) Save in addition to your 401k contributions. Just because you’ve maxed out your matching contribution, doesn’t mean that you should stop there. Consider opening a Roth IRA to save more.

4) Track expenses. To reiterate one of the tips in the article, by reducing how much you spend on non-essential expenses you can end up with a nice contribution to your retirement accounts. You can track expenses yourself or use a site like mint.com

5) Set up systematic contributions. It’s very easy to link your checking account to your retirement account and have contributions made to your investment account automatically. You can even explore the option of a payroll deduction.

Regardless of the strategy you adopt, remember that it will require self control. It’s very easy to shift dollars you earmarked for retirement to pay for that unexpected expense. Develop a plan, stick to it and review it periodically.