Changes in RMD ages provide more "gap years" for tax planning, allowing individuals to lower their lifetime tax liability. We also look at how capital gains on mutual funds affect taxes in retirement.
Change in RMD Age
So the SECURE Act, pushed the RMD age to 72 from 70.5. And now the SECURE Act 2.0 has actually pushed the RMD age from 72 to 73. Now if you've already taken RMDs and you're grandfathered in at whatever age you started, you have to keep taking them. But no one is actually going to pay a new RMD in 2023 because if you're 72, it got pushed back to 73.
And then actually, if you were born after 1960, then you get to wait till you're 75 to have to start taking your RMD. So that's great because the really good tax planning years are what we call the gap years between when you retire whether that be 62, 65, whatever, until RMD age which has now gone from 70.5 to 72 to 73. And then for those born after 1960, it is actually going to 75.
More years to do tax planning is great because that's going to help us lower your lifetime tax liability, which of course is always the goal, right?
There are RMD charts. I'm not going to go into full detail on that but basically the government gives us charts and everything is amortized by the chart, which gives you the denominator. Then you divide your previous year's IRA or 401(k) balance at December 31 by that denominator to determine how much your RMD is going to be.
We do the calculations for our clients, but oftentimes you custodian will tell you how much your RMD will be for that year.
A lot of times people don't realize how large RMDs can get as we age. Now, starting at age 73 and as you get older, the dominator gets smaller so the amount that you pay is going to get higher.
So let's say hypothetically, you have a million dollars in your pre-tax account.
- At age 73, the denominator is going to be 26.2. So if we take a million divided by 26.2, that's going to be about $37,736 for an annual RMD. So a good chunk, but not huge.
- Now let's fast forward to age 80. Let's say you've still got a million dollars in a pre-tax accountant. So the denominator is lower at 20.2. Let's say you take a million divided by 20.2, and that's going to be about $49,505. So it's getting larger, right?
- Now let's fast forward to age 90. If you've got a million dollars and your denominator is now 12.2, that's going to be about $81,967 that you're going to have to take out as a required minimum distribution.
- Now one last step, we're going to jump up to 100. So at age 100, that denominator is all the way down to 6.4. So you take a million divided by 6.4. That's going to be $156,250.
So this is what happens when I'm saying that a lot of times people are sitting on a tax bomb and they don't even know. Even at age 90, if you had to take out $82,000 from your pre tax account, that's going to stack on top of Social Security and on top of everything else. So that's going to create a big tax bomb or a higher lifetime tax liability than you want or that was probably necessary, if you had done proper tax planning earlier.
Next I want to cover capital gains and how that's going to pertain to you and your retirement. A lot of times people don't realize that if you own a mutual fund in your investment accounts, there might be gains showing up on your tax return but you're not really using that money to live on, so it's not really doing you any good other than maybe it's screwing up your tax return and maybe bumping you into thresholds that you don't want to be in or you're not even paying attention.
So the best way to show how this happens is just use an example. A lot of people know that story of Apple. Steve Jobs started Apple, got fired, and then they brought him back in around 1997 I believe it was. Anyway, the company was about three months from bankruptcy. So they bring him back and he says, Hey, we're going to do this, this, and this. We're going to cut all these products.
Then this great fund manager back in the day decides to buy Apple shares, thinking Okay, Steve Jobs comes back. I think this is going to be great. So they buy Apple shares at that point. Let's say they buy for $1. I don't know what they are split adjusted. It doesn't really matter. Now they're $180 or $190 a share.
So fast forward to a couple of years ago. You or your current advisor who does investment management, but no tax planning, says hey, you know what, we're gonna buy this fund. They've done great over time, (because they bought Apple back in 1997, right?). So you buy this mutual fund that bought Apple, and now they're sitting on all these gains going for $1 to $180 or whatever it is right now.
But then, all of a sudden, the mutual fund who has owned Apple the whole time says, You know what, I think Apple is great, but I think that there's some other stuff that I can do a better job with or is a better investment now a better investment now, so I'm going to sell Apple.
Even though you only owned the fund for past year or two, they sell and now you have to pay all the capital gains on that investment all along because of the type of mutual fund that you own it in. Is that fair? No, it's not fair. But that's how our tax code is set up right now.
Knowing what you own makes a big difference when it comes to taxes in retirement and how it's going to be taxed, because you're paying tax on all those gains over all those years when you didn't even own the stock. So that's not fair. But that's how it's done.
Other videos in this series:
- The Problem: Many Americans Are Sitting on a Retirement Tax Bomb
- The History of the Tax Code in The United States
- Taxes in Retirement 101 - How Taxes Relate to You in Retirement
- Taxes in Retirement 201 (Part 1) - RMDs & Capital Gains (This video)
- Taxes in Retirement 201 (Part 2) -Social Security & Medicare
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