Reader Question: How to Manage RMDs

How is it going? Wait, is there any point in asking?

We’re mentally in a difficult place. My kids are turning in schoolwork that literally just says, “School is bad” a bunch of times with a sad face at the top. There friends join the video conference and say how sad they are. Even our dog is sad almost all the time. I know that many of you are sad too. I hope you can find something to make the day a little better.

It’s been a tough time to write blog posts. Finances are either mostly okay for some people or terrible. I don’t know how to write about unemployment during this time. I’ve got nothing to share except for sympathy… and I’m not sure that’s useful. We’re fortunate that money is okay for now. I’m not making much with the blog, and there are no dogs to sit, but our passive income is doing okay. My wife’s job is still paying well. Our spending is down, so that’s helpful.

I had a reader reach out to me the other day with a different topic. This may not be the time to write about this, but the thought exercise made me feel better… almost like I can pretend things are normal for a little while.

How to Manange RMDs

For those that don’t know, RMDs are Required Minimum Distributions. If you are 72 (it used to be 70.5), the government wants you to start getting your money out of tax-advantaged accounts so they can tax you. Thus they require you take the money.

I’ve never thought much about this. It’s still quite a few years in the future for us and it falls into the category of a “good problem” to have.

However, the reader raised some interesting questions. (I’m not going to the share the whole conversation, just the highlights.)

In her case, she’s got a pension, Social Security, and this nest egg of savings. Between all that, she’s making more now than she was working. Most people expect to earn less in retirement and be in a lower tax bracket, but that’s not how it seems to be working out.

To compound the “good problem” to have she has few expenses with the house and car paid off. She has some things like lawn and snow removal, but I got the feeling they aren’t too bad.

She’s getting an excess amount of cash from RMDs that she has to take. Unfortunately, there aren’t a lot of good places to put that money. Banks are paying almost zero interest. CDs aren’t much better. This is a scary time to invest in the stock market. Personally, I feel that it might drop a lot. It doesn’t seem normal for the market to only be down 10-15% when unemployment is going through the roof and corporate profits are in the gutter.

I don’t have a lot of good answers for this reader, but I felt like I should try anyway. Here were some ideas I had:

1. The most important thing, is to have a financial expert look over the situation. A Certified Financial Planner (CFP) is a good start. One of my goals for the year was to do this for our own family. However, it’s hard to do that with businesses closed. If this isn’t possible, that’s not easy.

2. Invest in a bond ETF. My favorite is Vanguard’s BND. It pays a 2.5% dividend. That’s not very high, but it has been very safe during these times so far. It’s still high enough that it can support most people if they have other sources of income like a pension and Social Security.

3. A diverse, high-dividend paying ETF. I personally like iShares HDV ETF. It’s paying a 3.4% yield now, which is a lot better than banks. Of course, the stocks in it can go down (see above warning about the stock market), and companies may stop paying dividends. Without work and profits, it’s hard to imagine them having the cash to pay big dividends.

3a. Dividends are taxed at a favorable rate. This means that the earnings aren’t taxed as income, which would be in a (likely) higher tax bracket. As always, check with your tax professional about this.

4. Look into QLACs. A QLAC is a qualified longevity annuity contract. That’s a mouthful, right? It’s also a good topic for a finance professional. Essentially, as I understand it, QLACs allow people to put 25% or $135K (whichever is lower) of their retirement savings in another account that doesn’t get taxed. I want to stress that I don’t know this very well, so please see someone more qualified.

So that’s what I have. Do you have any more ideas? Most of these don’t really solve the RMD issue itself, but at least it helps manage it a bit.

I’ve been looking at investing more outside of pre-tax retirement accounts because the dividend tax treatment is so much better than regular income. Most of those ideas are on pause for now, as we try to navigate COVID-19.