Do you want a wealthy retirement without worrying about money? Welcome to “Retire in Texas”, where you will discover how to enjoy your faith, your family, and your freedom in the State of Texas—and, now, here's your host, financial advisor, author, and all-around good Texan, Darryl Lyons.
Darryl: Hey, this is Darryl Lyons, and you're listening to Retire in Texas. Thanks for tuning in. PAX Financial Group is the sponsor of this program. We can't give you specific investment, tax, and legal advice here, but visit PAXFinancialGroup.com for more information. If you need to speak to a financial advisor, text the word “Texas” to the number 74868. That's “Texas” to 74868.
Look, we're going to do a show, it's a solo show today, but I want to talk a little bit about retirement distributions. It's a little nerdy, but it's good and you're going to really appreciate it, because some of you guys are putting money in retirement, but you need to start thinking about what it looks like down the road when you're taking distributions, and some of you guys are taking distributions now and kind of don't know all the mechanics, so I'm going to provide clarity there. [01:11.1]
I think it’s important. Stephen Covey said, “Begin with the end of mind,” so I want you to kind of have an idea of how this whole distribution works. How do you get money out of the investments to kind of repeat your paycheck? I'm going to cover that in detail, and we'll do that as briefly as we can with as much meat on the bone as possible. I'm going to do this in a top-5 countdown approach.
No. 5: Mechanically, how do withdrawals from investments work? This is a question I get. Sometimes people don't ask. Sometimes people are afraid to ask. How it works is companies set up what they call an ACH (Automated Clearing House), and so they'll set it up. They look at your IRAs and they say, “Okay, we're going to take out $1,000 a month and it's going to hit your bank account on the third of each month.”
I'm using that just as an example. If it falls on a weekend, then it'll end up being the Monday following the third, but it'll be the third of each month, and using that ACH form, it'll transfer automatically to your bank account and it'll withdraw from your investments, lowering your investment account each and every month. [02:08.2]
You don't want to make too many mini-adjustments in that because it's just burdensome, basically, and administratively challenging, but that's basically how you replace your paycheck.
Now, what happens is you're going to say, “Okay, what about taxes from that? Do I pay the taxes or does--?” That depends. If you have an IRA, all the financial institutions will withhold taxes. Let's say, it's $1,000 a month. You can tell them, “Hey, can you withhold 20% for taxes?” and then they will, in turn, send that check off to the IRS for you so you don't have to worry about that. Then, at the end of the year, they'll make sure that they’ve sent enough. You can adjust it each year.
Look at your tax return each year, because you have an effective, a nominal and effective tax bracket. Many of you in retirement age are going to be paying, I'm guessing, under 10% because your standard deduction is going to cover a lot or it's going to reduce your taxable income quite a bit. [02:58.2]
You look at your effective tax rate when you get your tax return next year, and that's really the amount that you need to have withheld. But if you do 20%, then you're going to get a little tax refund each and every year, and that may be fine for you. You may enjoy that tax refund. But if you want to get a little bit more accurate, then look at your tax return. At the very bottom, it's going to have your effective tax rate and that would be your withholding.
By the way, that's on traditional IRAs, traditional 401(k)s. If you have a Roth, then you don't have any taxes due. Roths are completely tax-free. On non-IRAs, though, they don't do withholding typically, so you're going to have to do that yourself, because the taxes are not a byproduct of your withdrawals on a non-IRA. The taxes are not a byproduct of your withdrawals. The taxes on a non-IRA are a byproduct of the growth in the portfolio, so it's a different approach. Any withdrawal is irrelevant to the IRS. They're more concerned about the activity that went in there. There's no withholding done on what we call non-qualified non-retirement accounts. [04:00.0]
Okay, so that's the mechanics of how that works. Let's go to No. 4. What are the rules for withdrawals, if I'm before 59 and a half? So, 59 and a half. You’re not supposed to take your money out of IRAs before 59 and a half. There's a bunch of rules. You can find this on the IRS website, but if you die, then there's no penalty there. If you become disabled, you have to be permanently disabled. It's not just a temporary disability. There's no penalty there.
These are found mostly under Section 72(t) of the tax code, equal and substantial periodic payments. Believe it or not, you can take money out before age 59 and a half, at 55, as long as they're equal and periodic distribution, so that's nice.
Let's say you’re like, I really want to get out of this job and I'm waiting till I'm 59 and a half, and I can't wait any longer. You can take advantage of this Section 72(t) and do equal and periodic payments. Most financial advisors can guide you, and you can start taking money from your IRAs before 59 and a half. You just have to use this rule and follow the rules, and stick to them. If you mess up the rules, then they can claw back and take a penalty from your IRA. But you can, under Section 72(t), get equal payments without a penalty. [05:08.8]
First time homebuyers, you can do that, too. That's $10,000. This doesn't apply to your 401(k), but it does apply to your IRA.
Medical, you won't have a penalty there. It has to be above 10% of adjusted gross income, so pretty heavy-duty medical expenses. I think they did change that, though, to 7.5. You'll have to double-check me on that.
Some health insurance premiums, if you're unemployed.
Then there's several others, but qualified domestic retirement order, there's no penalty for that. Those are the big ones that I know of. Other than that, if you're a under 59 and a half, you take money out of your IRA, you are going to be subject to a 10% penalty and tax, which is pretty hefty—so really discouraging people to do that because that could come out to 30% of whatever you pull out, and that's just an expensive, expensive mistake. So, I want to discourage that and try to find if we can work within some of these rules. [05:58.2]
Now, the Roth IRA is awesome because you are subject to a 10% penalty—this is crazy. I know you're going to have to not trust me on this. Trust, but verify—but you can take out what you put into the Roth IRA without a penalty. They'll let you take out what you put in without a penalty, so it's a crazy kind of workaround that advisors can use. If people need money, we can take it from the Roth and, effectively, pay a bill without any tax implications. Roths are really flexible in terms of taking out distributions before 59 and a half without penalty. You just have to do it the right way.
Okay, so that's No. 4. No. 3: What are the rules for withdrawing after 72? Seventy-two is the new required minimum distribution age, and so if you're 70 and a half, that was the old rules. Now they're moving to 72. If you're 70 and a half in 2019, even 2020, you have to take out RMDs. But going forward, they're going to start doing, 2021, 2022, they're going to start doing 72, so 72 is the new 70 and a half. [07:05.6]
That's required minimum distributions. You have to start taking money out of any pre-tax. That would be traditional IRAs, not 401(k), so you have to take money out at 72—and when you have to take it out, you have to take it out by April 1 of the following year that you turn 72. Let's say you turned 72 this year. The next year, you're going to have to take out two distributions, required minimum distributions.
So, sometimes we kind of play with that and say, “Okay, let's do some distributions this year and some distributions next year.” The year you turn 72 is an important year that you work with your advisor to make sure that you don't take out double the distributions, because—let me repeat myself—when you turn 72 the following year, you can take out your RMD, not in the year you turn 72, but you can defer it to the following year up to April 1 of the following year. [07:56.2]
But then you're taking out both 72’s distribution and your 73’s distribution, so in that following year, you'll have two required minimum distributions, which could bump up your taxable income and increase your Medicare premium. So, you want to be careful that you work with your advisor on that first year that you're required to take the required minimum distributions, and if you don't take the RMDs, you're subject to a 50% penalty. Crazy penalty, I don't get it.
Here's the other rule. The financial institution is not responsible for the RMD. You are. So, don't expect the financial institution to do it for you. A lot of them, I know we do, we have systems set up to try to help as much as possible, but we've had some slip through the cracks over the years and it could be a 50% penalty, and it's on the individual.
The RMD is calculated using an actuarial table, so basically, in the first year, they look at life expectancy and they do look at beneficiaries, and they say, “Okay, take the amount of assets you have,” and I'm going to use this as an example, and divided by 22, let's say that's the number of years they think you're going to live, then that will be your required minimum distribution. That number changes every year and, again, it's subject to who you pick as a beneficiary. [09:06.7]
It's a lot to unpack on the 72 rules real quickly. Hope you got all that. If not, you can listen again and put it on at a slower pace or a faster pace. Okay, so, yeah, we covered three so far. Let's cover two more.
What sequence-of-return risk? This is the biggest risk for retirees. Gosh, I can't overemphasize this enough. When you're saving for retirement and I tell you to dollar-cost average, that's really good. You want the market to go down because you're putting in money each month and you're buying shares at a lower price. That's when you're saving.
The worst thing that can happen is you retire in 2008 and the market crashes, and you're taking money out. You're having it ACH into your bank account. You're eating your seed, and so when it sprouts back up, you have fewer seeds. So, eating your distribution when the market is going down is one of the biggest mistakes retirees can make and it's one of the things I focus in on more than anything, because it's the biggest risk for retirees and I’ve had so many people in our office retire at the wrong time, because we've been through a lot of tough markets and I’ve had people retire at the perfectly wrong time. [10:07.8]
This is just me, I feel we've done a good job navigating through that, and we may never ever get a pat on the back for it, but it's something that we think deeply about because we know sequence-of-return risk is critical. You do not want to eat your seed. You do not want to take distributions when the market is going down in the first years of retirement. You don't want to do that.
How do you solve that problem? I think there's two ways to solve the problem. One is to make distributions from a cash portion of your investment. If you have an investment, and I'm going to make it up, let's say you have $500,000, and you want to withdraw $1,000 a month. Rather than taking it from your portfolio, carve out some of your portfolio and put it in cash, and then take that distribution from the cash portion of your portfolio so that it's more stable. The other stuff can go haywire, but your cash portion is stable. That's one way to do it, and then replenish your cash every year and you can do that however you ever feel comfortable.
The other thing you could do is use annuities. You want to be careful to use annuities, but annuities do provide the protection against the sequence-of-return risk. [11:10.3]
That leads me to No. 1, the No. 1 question I get all of the time because of all of the crazy hilarious annuity sales people out there. They're nuts. They're crazy. They have all these radio shows. They say things that are just wrong. I definitely have an opinion on it, but misinformation is used a lot and it's certainly in the annuity space. The commissions they get on these things are crazy.
But, anyway, they have a place and annuities do have a place. We offer them. It's about, gosh, I want to say, I mean, it's less than-- it's got to be 5% of our total assets in our organization. It’s not much, but we do recognize that they serve a purpose and they serve an incredible purpose, certainly, the interest-rate environment. Because it impacts, annuities have to be right, so we have to know that the product is offering the credits that make sense. [11:57.3]
But also when a client is really nervous about the market long term, it does have its place, and so we use annuities. Every single annuity is placed in the context of a financial plan and no one should over-allocate to annuity. No one should put a hundred percent of their money in annuity. Nobody should really put more than-- 50% would be a stretch; 25%, okay. But you really want to be careful because it's not liquid, and then there's so many nuances to annuities. You don't want to wake up one day and say, “I regret getting this, because I didn't understand it at the time,” and then you can't do anything about it. You're like married to this thing.
So, you want to be careful not to over-allocate, but they absolutely serve their purpose. We've seen them time and again. We're not afraid to use them. We're not afraid to make the recommendation. We've been able to set up our organization where our advisors do not have a conflict of interest when they're making an annuity recommendation. Their compensation is materially the same when it comes to making a stock portfolio recommendation, a bond portfolio. They're fee-based advisors. There's not a conflict that exists there, so we feel comfortable using annuities in the right context. [13:02.8]
Now, I will say, do not buy an immediate annuity. Don't buy an immediate annuity. Interest rates are so low right now. In 1999, when I first started in this business, immediate annuities would get somebody a 10% or 11% interest rate and they would get that for the rest of their life. Right now, you're getting a 2% interest rate, so do not use immediate annuities right now. In five years, come back to me and we might be talking immediate annuities, but right now, don't use those and don't put too much in annuities, but I do think that they have their place.
There's our top-5 countdown for retirement distributions.
No. 5: Mechanically, how do retirement distributions work?
No. 4: What are the rules for me withdrawing before age 59 and a half?
No. 3: What are the rules for me withdrawing after 72?
No. 2: What is the sequence of return risk that I’ve heard about?
No. 1: Should I consider annuity?
That's a lot to unpack. I hope that was helpful. 18 to 80, the book I wrote a few years ago, does cover some of this, so you can grab that, and we've got plenty of other podcasts that cover some of these topics in more detail. But I hope that gave you an overview and I hope it helps you as you do your planning for next year.
And, remember, you think different when you think long-term. Have a great day. [14:07.4]
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