The RMD Shock at 75: What Every Woman Needs to Know

Hey everybody. So today we're going to be looking at RMDs, required minimum distributions. And if you have a traditional IRA, you are subject to RMDs. Every woman that has one is going to have them because the government requires you at a certain age to take them. So today we're going to be looking at a case study. Her name is Lisa. And we're going to look at Lisa's situation first. We're going to look at the risks and problems that she faces, and then we'll look at the solution.

Lisa's Situation

To get started with Lisa, Lisa is 65 years old. She has a brokerage account with $1.2 million in it, a traditional IRA with $1.5 million in it. She doesn't have any debt. She owns her home outright, and her Social Security at her full retirement age is going to be $3,000 per month. She is currently working part-time. She decided that she's going to leave her full-time job and then for about five years work a part-time job just to ease into her retirement. So, she'll stop working at 70.

What she's thinking right now is she has never thought about RMDs. So, she's wondering how she deals with them. And something else that is going to come into conversation in a little bit is she wants to leave her estate to her niece. So, Lisa has never been married. She doesn't have any children and she really wants her niece to be set up in the best way possible.

The Problem

At 75 years old, Lisa needs to take her RMD for the first time. It's required $104,000. And the problem and maybe a good problem to have is that it's more money than she needs. So the risk here is that there is a quite large tax impact. What happens is when you take your RMDs, you pay tax on that amount at your ordinary income tax rate. So, it's not a favorable tax rate like a dividend tax rate. It's the tax rate that you pay when you earn a salary at your job.

The other risk is that there's something called IRMAA and it's Medicare income related monthly adjustment amount. We're not going to go into detail in this video about it, but basically it's a monthly surcharge in addition to the standard premiums that you pay for Medicare. So, if you make over a certain amount and there are different thresholds and it gets the surcharge gets higher and higher, you pay more money on top of the standard premiums.

Long-Term Concerns

The long-term concern that Lisa has is that the RMD amount can continue to increase before and during RMD age. So to help understand what this means, if we look at the RMD formula, it's the account balance as of the last day of the year. And what also comes into play is what's called the life expectancy factor. At a certain age, you have a life expectancy factor. What this means is that the value of your traditional IRA at the last day of the year and the age, your age is going to determine how much you have to take out of your traditional IRA every year.

So hopefully your traditional IRA grows and grows and grows. And as that happens, your RMD also grows. As you get older, your RMD also grows, right? Because when you put your age into that formula, as you get older, the government is going to want more and more. It doesn't mean that your RMD every year is going to be larger than the last. If the market, for example, has a correction, then your RMD this year could be less than last year. Your RMD doesn't necessarily grow every year. It would be ideal, but it doesn't mean it happens every year. We really have a risk with Lisa that this is just going to keep getting worse. And it's a good thing because it means the account is growing, but it's also a bad thing because it also means her tax liability is increasing at the same time.

Tax Impact Analysis

Let's take a look at a chart here. And this is looking at the amount of taxes that Lisa has to pay. We can see from 2025 to about 2034, her taxes are much lower than 2035 up until 2041. Now, what happens at 2035? Well, at 2035, that is when she is 75, which is the first year she has to take money out of her traditional IRA. We see that she's not paying a lot in taxes relative to what she's going to in about let's call it 10 years, 9-10 years. So I want us to keep that in mind and we can see that over time her taxes are going to continue to grow and get to a quite sizable amount.

So just to put a little more color on this problem, we can see here that her effective tax rate is quite low, right? And then all of a sudden over here it starts to grow. And if we were to scroll down on this chart, it would continue to get higher. Her effective total tax rate continues to increase and increase and increase.

The Solution: Plan A vs Plan B

Let's take a look at the solution. So we have plan A, which is doing nothing. And then we have plan B, which is to plan strategically.

Plan A: Doing Nothing

Plan A, what does that entail? Well, if we do nothing, as we just talked about, hopefully over time the account continues to grow and grow and so did the taxes. So Lisa can just continue on paying taxes on that RMD every single year. And then you'll have higher lifetime taxes. And I feel kind of dumb saying this, but it just means that you're going to pay more taxes in your lifetime. It's not like lifetime taxes is some special tax that the government has. It just means you're going to pay more taxes over the course of your life.

We talked about IRMAA for a brief minute. You may have Lisa may have higher IRMAA premiums. And then there's less flexibility with income planning, meaning Lisa is going to be forced at 75 to take $104,000 out of her IRA whether she likes it or not. So you're going to be forced to do that. You don't have a choice. If you don't take that amount out, you are penalized in a quite large way.

So the other thing is that there's fewer options to leave a tax-efficient legacy. When Lisa's niece inherits this IRA, it's going to be known as an inherited IRA. And so what happens here is that Lisa's niece has to deplete that entire IRA within 10 years after Lisa passes away, meaning Lisa's niece is going to have also a quite large tax bill because you're taking a relatively sizable IRA and you're being forced to take distributions from that IRA to make sure that account value at the end of the 10 years is $0. So Lisa is nice enough to pass on her IRA to her niece, but her niece is also going to be left with quite a high tax bill like Lisa was.

Plan B: Strategic Planning with Roth Conversions

Or we can do plan B. And plan B is taking a look at what can be done to solve these problems. What can be done to solve these risks? And so one of the solutions could be a Roth conversion. Roth conversion is when you take money from your traditional IRA and you convert it to a Roth IRA. And so we can take these conversions and convert the money in Lisa's lower tax years.

So before we just took a look at there was a handful of years almost 9-10 years where Lisa had very low taxes because she left her full-time job went to her part-time job and she didn't have as much taxable income. So we can convert during those low tax years. We can reduce the RMD size and taxes later in life, right? Because as you take the money from the traditional IRA and move it to the Roth, that account value is going to go down. And when that account value goes down, so do the RMDs. And when the RMDs go down in value, so do the taxes.

We can also control Medicare premiums, which is IRMAA. And this is going to happen. If we're not taking as much from the traditional IRA in the form of RMDs, we're not going to have as much taxable income and that is going to lessen the chance of going into tax brackets where IRMAA premiums become a thing or become worse.

We can have more predictable tax efficient income in retirement. So Lisa doesn't need that $104,000 the entire thing. We can choose with a Roth IRA what we want to take out. If we want to take out anything, we don't have to take out anything at all. Roth IRAs, unlike traditional IRAs, do not have RMDs.

Greater flexibility for legacy and estate planning. So, Lisa wants to pass on her assets to her niece. Her niece, just like Lisa with a Roth IRA, doesn't get taxed when she takes money out of that Roth IRA. She still needs to deplete that account within 10 years of Lisa's passing, but she doesn't pay taxes on it.

Additional Strategy: Qualified Charitable Distributions

We can also do something, and we're not going to touch on it in this video, but we can do something called a QCD, which is a qualified charitable distribution. It's when you take money from your traditional IRA and directly donate it to a qualified charity. So, you can take your RMD amount, you have to be a certain age, and you're limited. You can take your RMD amount and donate it to a charity of your choosing.

Comparing the Results

We can do plan A. We can do plan B. Why don't we see what happens if we take a look at plan B and plan strategically? I just want us to take a look again at the chart where we saw the amount of taxes that Lisa would pay over time. And we looked at the about 9-10 years from 2025 to almost 2035 where Lisa's tax amount was much lower than the rest of her plan.

If we took plan B, what would that look like? Well, our taxes just went up. So, you might be saying, "Well, why do we want to do that?" Well, what's happening here is we're taking the traditional IRA money and converting parts of it every year into a Roth IRA. We're doing Roth conversions here. And what's happening is we are increasing in those 9-10 years her taxes. But look what's happening. Like take a look at 2041 for example. 2041 in this plan B scenario, she's paying just over $70,000 in taxes. If we go back to plan A doing nothing, she's paying just over $120,000 in taxes. So what's happening here is we are paying taxes from 2025 to 2035 instead of having this tax time bomb keep on growing and growing and growing and having more taxes later on in life. Instead we're paying the taxes now and having less later on.

And this is looking at a comparison between the plan A and plan B. Plan A is going to be what's in the yellow and the blue is plan B. So, as we can see, we're going to be paying with plan A much lower taxes in those first 9-10 years. And then as that traditional IRA continues to grow, hopefully so do the amount of taxes. Whereas plan B, we convert from those first 9-10 years. We're going to have higher taxes with plan B, but over time they're going to be lower than plan A. So, we're paying the taxes now to benefit later.

Impact on Income and IRMAA

This is the income amount before. So, this is no longer taxes. This is looking at Lisa's income. Before we were having these RMDs of $104,000, right? And here we are with income between 150 and $200,000. Right over here we are in the IRMAA 3 bracket right over here. This is going to be plan A. What happens with plan B? Well, all of a sudden that $104,000 RMD at 75 because of those conversions has now turned to about $64,000.

And what happens here? We are having less taxable income. So our tax bracket is lower right over here. And then look at this. Our IRMAA bracket because our taxable income is lower. So is the IRMAA surcharge that Lisa is going to pay. And the reason being is because instead of $104,000, Lisa is going to be having an RMD of $64,000. That's the amazing impact that this strategic planning doing these Roth conversions is going to have for Lisa.

Asset Allocation Visualization

And this is just going to give you a visual of what plan B looks like in terms of where her assets are going to be located. In the dark blue here is going to be the taxable balance. That's her brokerage account. The light blue that tax deferred, that's her traditional. And in the yellow, that is the Roth IRA. Before we would have just saw that light blue and the dark blue, whereas now we have introduced a Roth IRA. So now we have a tax-free balance as well, right? Because the Roth IRA, you don't pay any taxes on it, whereas the traditional IRA, you do. That's why it's called tax deferred. And Roth is tax-free.

The Bottom Line Benefits

And what's really cool here is that Lisa gets to save about 3% on her average tax rate. And what that means is that over time, she'll save about $300,000 in total taxes, about $295,000. And then what's also really awesome is Lisa wants to make sure that her niece is set up in a really wonderful way. Well, what happens here is the net legacy, meaning what Lisa gets to pass on to her niece, goes up by about $214,000. So, that's a nice addition as well.

Key Takeaways

Let's take a look at the takeaways here. First one is plan for your RMDs. If you have a traditional IRA, every woman is going to be required to take money out of that traditional IRA. The government wants their tax money. So, since they're not optional and you're going to face them, you might as well plan for it and do what you can to help yourself out.

And what's better than just doing something is doing it early because you will have more control over the situation. For example, if Lisa just waited until the last year before her RMDs kicked in. So, if she just started thinking about these at 74, she would only have a year to figure out what to do with her RMDs. Instead, she planned early. So, she had almost 10 years to plan for these RMDs. She was able because of that to take advantage of those lower tax years. And so, that really helped her out. So, plan early. They're going to happen. Just make sure you're doing everything you can to help yourself out.

And as we just said, convert in lower tax years. If you have a period of time before those RMDs kick in, before your social security kicks in, take advantage of converting money from a traditional to a Roth in those low tax years because you're going to pay less in taxes when you have a lower tax rate than when you have a higher tax rate. So, take that time to convert those traditional dollars to Roth.

Lastly, greater flexibility. And when I say greater flexibility, I mean in two different ways. One is going to be retirement income. The second is going to be legacy planning. Retirement income in Lisa's case, $104,000. She didn't need all that money, but she's forced to take it because the government says so. So, because she was able to do those Roth conversions in those lower tax years, she now can take money out of her Roth when she wants, or if she wants to do it at all, she might just say, you know what, I don't need the money from the Roth IRA. I'm just going to leave it in there. Versus the traditional, she's forced to take that money out whether she wants it or not and pay taxes on it.

Legacy planning, she's now able to have her niece inherit this Roth IRA and the niece will not have to pay taxes on that money. So, if Lisa, for example, didn't need to take any money out of the Roth IRA, she can just look at it as a tax-free inheritance for her niece, which is so awesome, right? Retirement income flexibility and legacy planning flexibility as well.

I hope you learned a little bit more about RMDs. Maybe learned something that you didn't know before. If you have a relatively larger RMD that you're expecting in the future, there are strategies you can take to lessen that, to lessen that problem, to lessen that risk. Thank you so much for watching and until next time, I'll see you on the next episode.