RMD Tips for a Down Market

Of all the investing maxims we have seen, we can’t recall any that included “sell low” as timeless advice. More often, it is a thing people do out of panic, then regret later as a market recovery leaves them behind. But what if you have no choice? That is the situation retirees may be facing if they haven’t yet taken their annual mandatory minimum withdrawals from their traditional 401(k)s and IRAs this year. The prospect of reducing stock exposure at levels well below early-year highs—thereby reducing exposure to the eventual rebound—is far from attractive. Thankfully, there are ways to lessen the blow.

Yes, those who turned 72 this year and older with tax-deferred retirement savings accounts must take required minimum distributions (RMDs) or risk facing a stiff 50% penalty on the amount not withdrawn. What is your RMD? Divide last year’s ending balance for your tax-deferred plan(s) by your—and perhaps your spouse’s—remaining-year life expectancy, which the IRS helpfully estimates (Uniform, Single, Joint). Or, ask your financial professional to tabulate it for you. This is the minimum amount you must withdraw this year—which is then subject to taxes. It is how Uncle Sam ensures he gets his slice of those long tax-deferred monies.

Federal law mandates retirees withdraw these funds. But they don’t mandate what you must do with them, which gives people some flexibility. If you don’t need the money straight away and can cover the taxes, you might find it beneficial to withdraw your RMD amount in-kind—simply transferring securities into a taxable brokerage account in the amount required. You still have to pay taxes on the withdrawal, but this lets you stay invested. Then, you are able to sell at your discretion when you need to raise cash for living expenses or other purposes.

You might also consider in-kind charitable distributions to satisfy your RMD and avoid taxes altogether. The IRS allows you to donate securities directly to qualified organizations, satisfying your RMD without having to pay taxes on it—at least up to $100,000. This lets you help out a charity you like and sidestep the taxman at the same time.

We know not everyone is able to do this. If you rely on your annual RMD to fund expenses, selling securities to take your RMDs—and paying taxes on them—is likely unavoidable. However, if you keep the rest of your account invested to capture the recovery, taking your RMD likely isn’t an insurmountable hurdle preventing you from participating in a recovery. The amount left will still compound over time. If you choose to, you could also take your RMD in installments or pull it in-kind, selling some of the securities as you need cash. This isn’t requisite, of course, but it is a way to maintain market exposure.

To see the effect of an RMD withdrawal late in a bear market, consider a hypothetical investor turning 72 in 2008 with $500,000 in a tax-deferred retirement account. (Understanding that before 2019’s retirement system overhaul, you were required to start taking distributions earlier, at age 70 ½.) Using today’s life expectancy tables—unrealistic, but just to illustrate the point—the investor withdraws $18,248 ($500,000 divided by 27.4 years, from the IRS’s Uniform Lifetime Distribution Period) at 2008’s end. The difference between a half-million dollar account and the same less the RMD would have been $82,763 ending 2021.^[i] That is significant, due to compounding’s power, but in the larger scheme of things, the remaining $481,752 after the required distribution, if it remained invested, would hypothetically grow, too. Of course, real-life investors would have had to continue taking RMDs year after year (except for the suspensions in 2009 and 2020). This isn’t meant to be an analysis of the long-term impact of taking RMDs, though—rather, we are simply showing that if you have to reduce your stock exposure by several thousand dollars late in a bear market, it isn’t automatically a huge, permanent setback.

Now, if you do choose to mitigate RMDs’ impact by transferring shares in-kind or taking them piecemeal, we recommend speaking to your financial professional sooner rather than later. Remember, if you are moving shares in-kind, the timing is basically irrelevant. And if you don’t have a taxable brokerage account set up, it will likely take a few days to open and execute the movement of securities. Best not to rush around right at yearend.