July 27, 2017

RMD Mistake: Depositing to Your Checking Account

RMD Mistake: Depositing to Your Checking Account

Required Minimum Distributions (RMDs) are complex and there are many ways to make both large and small mistakes.

One common mistake is depositing your RMD directly into your checking account to supplement your standard of living. Although legally fine, this often causes you to accidentally increase your spending every year because more money is available in your checking account to spend.

RMDs are designed to make you withdraw an ever-increasing percentage of your portfolio. The first year of RMDs, you are 70 years old, the divisor you use is 27.4, and so you are required to withdraw 3.65% of your portfolio. When you are 80 years old, your divisor will be 18.7, and you will be withdrawing 5.35% from your portfolio. In just 10 years, that is a 46.58% increase in IRA distributions.

We recommend a safe withdrawal rate of 4.77% and 6.22% at the ages 70 and 80 respectively, making the safe increase in rate of withdrawal over those years 30.40%. This means, assuming you didn’t have cash flow problems before the RMD increase, you will likely have an abundance of cash in your checking account from the RMD increase. This will either make you spend more than you should or have cash build up in your checking account, neither of which are ideal.

It is wise to set up a system that curbs your temptation to spend more just because the IRS made you take money out of a tax-advantaged account. Schemes to remedy the problem, such as periodically moving excess cash to your brokerage account, are hard to stay on top of. This is especially true if your annual RMD increases are effectively automated for you by your custodian or advisor.

One of the best alternatives is to reverse the example above: deposit your RMD into your brokerage account instead of checking and then have a standard of living withdrawal scheduled to flow from your brokerage account to your checking. Mathematically and legally, there is no difference between this strategy and having your RMD deposit straight into your checking account. But so long as you don’t deliberately increase your automatic standard-of-living withdrawal, when your RMD increases, you will not be tempted to spend more as a result. Instead, as your RMD increases, so will your brokerage account’s savings. With a financial advisor there to invest this remainder, you will get the benefit of saving and investing the remainder automatically.

Across rolling 30-year time periods, the S&P 500 had average annualized returns of over 10%. With that average rate of return, it only takes seven years for your investments to double in value. Leaving behind the extra money from your RMD in your brokerage account can be of great value over your remaining lifetime. Don’t let the IRS rules about IRA withdrawals tempt you into spending money you had planned to save.

Photo used here under Flickr Creative Commons.

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About Megan Russell

Megan Russell+ is the Chief Operating Officer for Marotta Wealth Management. She studied Cognitive Science at the University of Virginia and now specializes in explaining the complexities of economics and finance. Megan loves formal logic, creative writing, and kittens.

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