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How Much do Your Clients Really Know About Required Minimum Distributions?

As the front end of the first wave of baby boomers begins turning 70½, a maze of complex decisions surrounding required minimum distributions (RMDs) for retirement accounts including 401(k)s and IRAs eagerly awaits.

Russ Shipman, senior vice president and managing director of Janus’ Retirement Strategy Group in Denver, Colo., shares what he believes is critical to keep in mind as you talk to your clients about the risks and opportunities related to these obligatory annual payouts.

What do you see as some of the biggest misconceptions with RMDs facing today’s retirees?

Shipman: Understandably, a lot of people just don’t appreciate the complexity, not to mention RMDs often come due before they know it. The first year in particular is especially confusing, given the 70½ triggering event. Many people by default will assume that their IRA or account holder will be responsible for calculating their minimums since those are the people shipping them a check. The hard truth is different. Granted, custodians and plan administrators routinely calculate RMD, but the accuracy and timely execution is on the account owner—who may not be aware of the tables in Internal Revenue Service Appendix B to Publication 590-B (see Laura Saunders’ Wall Street Journal Article “Everything You Need to Know About Required 401(K) and IRA Withdrawals”).

Additionally, if clients have multiple retirement accounts, the administrators do their calculations independently, rather than accounting for the sum of what they must withdraw, so selecting what to withdraw should be done thoughtfully and with good advice (Note: for IRAs, a saver may take required payout distributions disproportionately across multiple IRA accounts as long as the aggregate satisfies the correct total. Payout distributions from 401(k)s must be computed separately and come from each account). The rules can be even more confusing for people who are still working at age 70, which is increasingly common as Americans enjoy longer and healthier lives.

What are some of the options that retirees may not be aware of as they approach distribution age?

Shipman: The good news is that there are many options, and financial advisers can help by presenting these to their clients well before the first RMD comes due. Advisers can help clients look at fees associated with each of their retirement accounts, to start. They can also look at the types of investments they may or may not want to hold or withdraw from—for example, if a client has investments in a closed fund, they may never have access to it again if they take a balance to zero. Or, they may not want to touch a bond-heavy fund if they are getting desired tax-advantaged income there. They can also take distributions in different ways—lump sum or monthly, or through in-kind shares or real estate in certain instances. There are also some tax-advantaged options around how to spend it – such as charitable donations, which may come with additional tax benefits.

What are the biggest risks of not getting the right advice before structuring distributions?

Shipman: The penalty for not taking an RMD is incredibly steep—50 percent of the required distribution. As the government sees it, they’ve let people enjoy tax-free growth for years, and now they expect savers to start paying regular income tax on their distributions, Roth investments aside, of course. There could also be implications for the heirs of those taking incorrect RMDs—they could inherit the burden of a miscalculation.

What else can advisers do to help?

Shipman: Start the conversations early—long before the RMD is due. It may take some time for clients to wrap their heads around what this all means, what they want to do with the money, and where they want to source it, account-wise. Advisers can help by looking across different accounts and cost structures, and also connecting clients to providers of sound, comprehensive tax advice. Don’t make assumptions—have the conversation! Clients may not know what they don’t know, and your good and valuable advice around all things RMDs is needed.