How to keep required minimum distributions invested in a down market
The deadline for mandatory retirement plan withdrawals is fast approaching, which could force some retirees to sell assets in a down market. But experts say there may be ways to reduce the negative effects.
Required minimum distributionsknown as RMDs, are annual amounts that must be taken from certain retirement accounts, such as 401(k) plans and most individual retirement accounts.
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RMDs start when you turn 72with a deadline of 1 April the following year for your first withdrawal and a due date of 31 December for future years.
Although it has been a tough year for the stock market, there is a steep IRS penalty for missing RMD deadlines – 50% of the amount that should have been withdrawn.
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“This is obviously not the right time to sell these assets because they are at a loss,” said certified financial planner John Loyd, owner of The Wealth Planner in Fort Worth, Texas.
From midday on December 7 S&P 500 index is a decrease of more than 17% for 2022, and Bloomberg US Aggregate the bond index is down almost 12% for the year.
Why you need to manage ‘order of return’ risk
Research shows that the timing of selling assets and pulling funds from your portfolio can be “tremendously powerful,” said Anthony Watson, a CFP and founder and president of Thrive Retirement Specialists in Dearborn, Michigan.
The value of assets when you make withdrawals can change the size of your nest egg significantly over time, known as “sequence of returns” riskand managing that risk is “at the heart of retirement planning,” Watson said.
Consider “journaling” to keep your RMD invested
If you don’t need your RMD for immediate living expenses, there are a few ways to keep the funds invested, experts say.
One option, known as “bookkeeping,” moves the assets from your retirement account to a brokerage account without selling. “Not a lot of people are aware of that,” Loyd said.
Like an RMD, journaling still counts as a withdrawal for tax purposes, meaning you’ll receive Form 1099-R to report the transfer as income on your return, he said.
While journaling avoids market timeouts, it’s difficult to gauge the exact dollar amount because market values fluctuate and you may need another withdrawal to fully satisfy your RMD, he said.
Plus, most retirees withhold taxes through their RMDs, which isn’t possible when they book assets, Loyd said. Typically, he uses the second withdrawal for tax withholding.
Either way, you’ll want to build in enough time to complete both transactions before the deadline because “the IRS is not very lenient when it comes to mistakes,” Loyd said.
Avoid ‘execution risk’ by selling and reinvesting
While record keeping keeps assets in the market longer, some advisors prefer to avoid “execution risk” by selling assets, withdrawing the proceeds and then reinvesting in a brokerage account.
It takes a few days for RMD funds to settle, but Watson sees record keeping as “overly complicated” and prefers to reinvest the funds immediately after the withdrawal clears.