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Required Minimum Distributions – Rich Person Problems

You can start accessing your qualified retirement accounts starting at age 60. This includes your 401k, 403b, 457, IRA, Keogh, etc. But by age 70 you must access your retirement accounts or else face a tax penalty. This brings up the topic of required minimum distributions (RMD).

Having excess money is a good problem to have but there are tax consequences to consider. Imagine you are 70 years old and you have a $5,000,000 retirement account, but you’re living well on ‘only’ $75,000/year.

Because of RMD’s the IRS will force you to withdraw nearly $180,000 every years from your retirement accounts.

As for the tax consequences, that $180,000 is considered pre-tax income which means that you’ll be owing income taxes on that, both on the federal and state level.

Also consider, you’ll likely be retired by age 70 and therefore will have very few potential tax deductions. So, that $180,000 will be taxed quite aggressively.


Required minimum distributions

The purpose of RMD’s is to empty out your retirement accounts by the time you die. Since the mortality tables the IRS uses show that the average 70-year-old will live 27 years, they use 3.7% (1/27) to come up with your first distribution amount.

It’s not the end of the world to be forced to withdraw your money from your retirement accounts. The major downside, however, are the taxes for those of us with sizeable retirement balances.


Roth conversions

Most medical professionals who are nearing retirement will have way more money than they’ll need. When it comes to retirement, excess is somehow excusable.

Most of the retiree’s money will be in IRA’s because as we leave our jobs we tend to roll our 401k’s into IRA’s.

One option to avoid required minimum distributions is to convert your IRA into a Roth IRA. This conversion requires that you pay taxes on the converted amount since you are going from a pre-tax holding to a post-tax retirement holding.

Lump-sum conversion

The reason you don’t want to convert your $5M IRA stash into a $5M Roth IRA is because you’ll have a very ugly tax bill.

Converting $5M all-at-once will put you in a high tax bracket and you’ll owe both federal and state income taxes on that conversion. Figure 40% – that’s $2M of taxes which you’ll be giving up because of this lump-sum conversion.

Gradual Roth conversions

Another option is to gradually convert your IRA money into a Roth IRA over several years as you’re getting closer to retirement. You already got a tax deduction during your working years, so don’t be too stingy with paying some taxes on the conversion here.

This is a great option for the early retiree. If your income is minimal then you’ll be in a low income tax bracket. This allows you to convert a few thousand dollars a year from your IRA into a Roth IRA.

You’ll have to add this converted amount to your total income for the year. If I had $30,000 of income from Just Answer and converted $20,000 of my IRA, I would have a total taxable income of $50,000.

But I might have zero income for the year because I decided to have no earned income. In 2018 my standard deduction will be $12,000 or $18,000 if I claim one of my parents. I could convery up to $12,000 of my IRA to a Roth without paying any taxes.

Reverse rollover IRA ➝ 401k

There are numerous tricks to use to avoid the RMD problems and one of them is to roll your IRA into your employer’s 401k if you are still working.

This will apply to very few individuals but it is something that can be manufactured if needed. The 401k sponsor has to allow this reverse rollover but it seems that quite a few do.

Last spring I was teaching at the Portland Community College for just 4 hours a week. Not only was I getting free health insurance but I was also offered a 401k. I could have rolled all of my IRA into this 401k in order to avoid RMD’s if I was 70+.

The bigger issue at hand is that you’ll just be delaying the inevitable. Eventually you’ll have to part with your employer and eventually you’ll have to deal with those RMD issues.


Saving too much

I guess this brings me to the captain obvious statement, saving too much might feel all warm and gooey, but it has financial consequences such as dealing with required minimum distributions. Not to mention, asset protection drama and estate planning headaches.

I’m 40 years old and my $500,000 retirement account is likely going to balloon to something like $1.5M by the time I’m 60 and $2.2M by age 70.

I have no intention to die rich and don’t intend to pay Uncle Sam more money in taxes than I already have over my lifetime. I believe in taxes, don’t get me wrong, but at this time my country’s spending isn’t in line with my own agenda so I prefer to curb my tax contributions.


Saving for retirement

The advantage of maxing out retirement accounts is that you’ll save money on taxes. But another way of saving money on taxes is to earn less money.

Another method would be to earn profits from a business rather than employment income which allows for more deductions, thus lower taxes.

That’s what I have been trying to do over the past few years. I have stopped being employed and focused on my own business. Currently I’m a sole proprietor which has saved me a lot of money on taxes.

I have battled with the idea of contributing to a solo 401k in order to decrease my taxes. But I don’t want more money in my retirement accounts – I have more than enough money. In fact, I have oversaved for retirement.

Taxable accounts

Fortunately, there is never a limit nor a penalty for putting money in your taxable accounts. You can use these accounts for retirement just as much as you can use your IRA or 401k.

I have around $200k in my taxable brokerage account. Contributing any excess earnings/income to this won’t offer me a tax break but at least I can spend from this account when and how I want.


Tax law changes

Tax laws will change – that’s a given. Will they change to benefit the wealthy medical professionals or the lower-income workers?

As long as I keep my spending low, my income needs will remain low. This means that I’ll likely be protected by future legislature.

One thing that hasn’t yet been written into the tax law is a net worth penalty. Currently, I can have a $10M net worth and I won’t be denied SS or Medicare. I won’t have to pay higher taxes because of my higher net worth alone. Will that change in the future?


2 replies on “Required Minimum Distributions – Rich Person Problems”

RMD is indeed very tricky to navigate through so the best is to start converting early and thus you have more years to convert at lower amounts, hopefully staying in the lower tax brackets while doing so.

This is another area where retiring early can be of benefit as you can potentially have a few decades to do your conversions and minimizing the tax hit along the way.

RMD is a good problem to have but a resource killer.
My main approach would be to not oversave in tax-deferred accounts. Seems like that money could be put to better use. Tax savings alone isn’t a savvy enough reason to max out retirement accounts because no matter what you do, you’ll have to pay taxes on your income someday.
There are advanced strategies of converting small IRA amounts into Roth without a penny in taxes which would make truly tax-free income but the average medical professional is unlikely to have such a chaotic fluctuation in their income and spending to be able to finagle that.

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