Thinking Differently About Required Minimum Distributions

In 1987, the IRS created rules to require the distribution of retirement plan assets and set 70½ as the age at which these distributions would be required to begin.  Although not mentioned in the legislation or tax code, this age was chosen based on a Biblical reference to old age: “The days of our years are threescore and ten”.  As a result, individuals living beyond this Biblical life span (plus the obligatory ½ year) are congratulated by the IRS with the requirement, not opportunity, to take annual minimum distributions from retirement plan accounts.

Usually in the 4th quarter of every year, we calculate and execute these required minimum distributions (RMDs) for clients based on the appropriate life expectancy table provided by the IRS.  However, we generally take the less travelled path and recommend that the RMD be executed by an in-kind transfer of securities rather than by a transfer of cash.  This means that, depending on the situation, we meet the RMD by transferring the exact RMD calculated amount of a security (or securities) from the IRA account to a taxable brokerage account.  This less well known and infrequently used technique does not help to avoid the tax that is otherwise due on the distribution.  That tax is unavoidable.  However, there are three simple reasons why we tend to recommend this unique approach in the majority of situations.

1) Saves Transaction Costs.  Selling positions to raise funds for the RMD may incur transaction costs.  Transferring positions in-kind avoids these expenses.

2) Saves Rebalancing Costs.  If the RMD represents a meaningful value and there are only a few positions in the IRA, sales executed in the IRA to raise cash may necessitate trading in other accounts to rebalance the portfolio back to targeted levels.  In these cases, there are not only sales in the IRA but also transactions in other accounts which can result in additional transaction costs and additional taxes.

3) Disassociates Government Mandated Distributions from Spending.  Studies in behavioral economics demonstrate that an individual is likely to treat a windfall such as a tax refund or a bonus differently than earned income.  That is, a bonus or tax refund is more likely to be spent than saved when compared with earned income.  The same behavioral framing tends to be applied by individuals to cash RMDs and these dollars get treated like a bonus. 

The government mandates the amount of a required distribution and reaps the benefit of the resulting tax.  There is no avoiding this.  But individuals who take the required distribution as cash are more likely to treat these funds as a windfall and spend the cash in short order, resulting in a secondary benefit to the government (increased spending).  We suggest that clients determine their own spending and not let the government fulfill this role.  Avoiding the cash RMD helps to minimize the unintentional behavioral tendencies which can derail a beneficial spending discipline.

Closing Comments

Implementing an in-kind transfer to fulfill the RMD is not complicated nor does it require any extra effort but most individuals and many professionals are not even aware that this option exists.  Completing the RMD this way is not appropriate in all situations but the method provides valuable advantages which should not be ignored.  

Print Friendly

Leave a Reply

Your email address will not be published. Required fields are marked *

Shares