Market Musings Blog

The Mystery of Traditional IRA Withdrawals

We are asked more often these days about required minimum withdrawals – how they work, why they must happen, and particularly, can taxes on RMDs be avoided.

The concept of the IRA contains an implicit agreement between you, as the IRA owner, and the federal government. The deal is this: you get to put away money (and often deduct those contributions), and you get to accumulate your earnings tax free, but only until you turn 70 ½. (No, we don’t know why the age 70 ½ was chosen, except it seems to be a compromise between retirement age and ‘really old’.) Once you turn 70 ½, the IRS wants its pound of flesh, and it insists that you draw the money out on a schedule that’s designed to exhaust the IRA, or nearly so, during your lifetime, so that money can finally be taxed. Overall, it’s a good deal, since it is better to pay taxes in the future versus today. (The ROTH flips this relationship on its head, agreeing that if you pay tax now, you get to get out of paying tax during accumulation and later.)

The tax on RMDs really can’t be avoided. The closest to avoidance is the Qualified Charitable Distribution, which allows you to donate your RMD or part of it directly to a charity (not your own foundation by the way). In that case, the tax on the withdrawal is nearly or completely cancelled by the deduction for the donation.

One hallmark of IRA RMDs is that they generally grow larger the longer you live. The RMD calculation uses the 12/31 prior year market value and your age and life expectancy to come to an amount that must be drawn (inherited IRAs and IRAs with young beneficiaries use other factors in the calculation as well). Each year, your RMD can rise due to a higher market value and/or a shorter life expectancy. The table below shows how life expectancy can affect draws:

As you can see, living into your 90s kicks off a 10% withdrawal rate.

The gradual acceleration of withdrawals makes management of this process critical. High cash flow – ie, choosing stocks with higher than average dividend yields and gearing the bond portion of the portfolio towards higher yields – is one way to deal with the depletion of the IRA asset base. More risk tolerant investors might want to trust capital appreciation in stocks to ‘pay for’ their distributions, but in a bear market, that can produce a disaster.

However one chooses to manage the distribution phase of traditional IRAs, it’s wise to remember that when staring at a $1 million IRA, you don’t really have $1 million; you have $1 million minus the tax that will be paid as that asset base pays your RMDs. This is a critical fact for retirement planning.

Market ‘Dips’ and Market ‘Corrections’

As the market sank this last week, we had a few comments from clients about this ‘rocky ride’. (One note of appreciation – these clients were calling with more concern for us than their portfolios! Thanks for that!)

Now is a good time to review a few statistics about market movements. First of all, it’s hard to remember this after last year, but nearly every calendar year since 1926 has contained a ‘dip’ of around -5% to -7%, and many years have contained more than one ‘dip’. On average, these moves happen at least every year, and over some shorter time frames, they happen twice a year! So we can consider this kind of movement normal. What’s not normal is going without a 5% correction, like we did last year.

Furthermore, ‘corrections’, of more than -10%, happen about 2/3 of the time, also within the range of normal.

One alarming feature of both dips and corrections, which tends to imbue them with more importance than they deserve, is that they happen fast. Markets rarely slide centimeter by centimeter over a long period of time. Instead they tend to plunge. Meanwhile, the recovery from the dip or correction can take months, making this feel all the worse. However, recovery occurs – so far – 100% of the time. So using a correction or a dip to buy assets is smart, provided the increased exposure synchs up with your financial plan.

An Addendum on Security

We had some feedback to our earlier blog on security, specifically around passwords. Our commenter indicated that her passwords were turning out to be too weak and she suggested that we augment our earlier post with some sites that can improve password quality – a worthy suggestion.

Here are a few password generators:

If you just want to check your own chosen password for strength, try this site:

Additionally, there are a number of services to keep track of all your odd passwords, but of course you have to remember your master password – and that one can be hacked too. We often use Roboform, here:

Happy browsing!




Charitable Giving: How Much is Normal?

Americans are pretty charitable, and we’re not just talking about the rich. Generally, Americans give away between 3% and 4% of adjusted gross income per year, across all income levels, though giving tends to be a little higher at the lowest end of the income spectrum. Interestingly, isolating giving to just donors, instead of the entire population, totals are about one percentage point higher. So in the population of “donors only”, at the $100,000 income level, donations run about $4200. For all taxpayers at that level, donations are around $3700. Further, amounts given as a percent of adjusted gross income have remained very stable over the years.

Keep in mind that if you stray much higher than these figures, or outside the realm of any ‘norms’ tax-wise, you essentially flag yourself as an audit candidate. That’s not a reason to be stingy, but it is a reason to keep meticulous records if you have large charitable contributions.

What if you are asset-rich but don’t have much income? Maybe you own real estate or a large portfolio of lower yielding stocks and municipal bonds that don’t generate a high taxable income. It’s harder to find figures that correspond to how much is normal or even appropriate to give away where assets are high but income is low. However, we found an old study that investigated lifetime giving as a percentage of total wealth, using later-filed estate tax returns. Turns out that people give away about 0.4% to 0.5% of wealth per year, then upon death, charitable giving via estate planning spikes. People clearly have a preference for retaining wealth while alive, even when it cannot be consumed; then being generous at death.

Finally, a note on the new tax bill: the bill hikes the amount of AGI that a person can give away and still deduct to 60% from 50%. It’s hard to imagine giving away that much income, of course.

New Tax Bill, Provisions You Haven’t Heard About

The new tax bill is just about 1100 pages long, and many of its provisions are very particular to certain situations, such as residents of high tax states, those subject to AMT, and so forth. For specific questions about your tax situation and the bill’s new provisions, be sure to talk to your accountant. That said, here are some little known provisions that will affect investors:

  1. The exemption from AMT taxation was hiked, to take account for the fact that inflation has caused more folks to fall into the AMT trap.
  2. Estates can now be nearly twice as large before paying tax, up to $10 million, with another hike due to inflation to over $11 million expected in 2018.
  3. Phase out of the subsidy for purchasing an electric car. This one is complicated. It is geared to each manufacturer’s production. Once a car maker has constructed its 200,000th electric car, the $7500 subsidy associated with buying that maker’s EVs begins to decline. So Tesla’s subsidies will run out relatively quickly, while makers who have barely made one car will take months if not years to run out their subsidies.
  4. No more deduction for home equity line of credit interest.
  5. Private purpose municipal bonds, earlier on the chopping block, were preserved, so these can still be offered to muni investors. That is important for maintaining supply in this market.
  6. Section 529 college savings plans can now be used for elementary and secondary school education, not just for college. This vastly improves these accounts’ usability.

Per above, any questions about the bill and its effect on your particular tax situation, we suggest a quick call to your accountant.