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  • Your Ten Minutes Are Up - How RMDs Would Really Work 0 comments
    Sep 8, 2013 9:06 AM | about stocks: VTI, AGG

    My colleagues and I once agreed, tongue in cheek, that everybody would get a turn whining and complaining for 10 minutes. After that, we would get back to work.

    I have heard and read a lot of complaining recently about Required Minimum Distributions. They destroy wealth! They eat in to principal! They are unfair! And so on. Because of "RMD anxiety disorder," many seniors are so worried about taxes that they completely panic. This is great for commissioned salespeople who sell fancy, expensive annuities, but not for the investors affected.

    To see how dire the RMD situation really is, I dreamed up Edna, who was born in 1942. As of January 1, 2012, she had exactly $1 million in an IRA, invested in a 50/50 mix of Vanguard Total Stock Market ETF (NYSEARCA:VTI) and iShares Total Bond Market ETF (NYSEARCA:AGG), with no dividend reinvestment.

    Edna has sufficient income from pensions, Social Security, and after-tax investments to put her just at the top of the 25% tax bracket. She has no need for a discretionary withdrawal from her IRA, so she makes her first-ever distribution on January 2, 2013.

    Edna's balance on December 31, 2012 is $1,106,154. Her RMD is 3.65% of this amount, or $40,375. She sells 193 shares of VTI. These proceeds, along with the cash balance in her IRA, satisfy her RMD. After the sale and withdrawal, based on that day's closing prices, her IRA balance is $1,094,516.

    Edna's allocates 28%, or $11,305, for taxes, leaving her with $29,070. This money is Edna's to use as she wish.

    The key point here is that Edna's after-tax amount of $29,070 is still in play if she wants it to be. The gloom-and-doomers write as if this money just disappears from the face of the earth. Nonsense! Either Edna needs/wants the money anyway, in which case it would get withdrawn (and taxed) anyway; or she doesn't, in which case she is now holding assets in an after-tax account. After many years of tax deferral, she is finally paying income taxes equal to 1.02% of her retirement assets. Paying taxes is never pleasant, but how is this a panic-inducing catastrophe?

    Edna's ten minutes are up.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I have a few years to go before entering RMD territory, but it's been on my mind (and in the news) a lot lately. My home state, Texas, does not have an income tax.

    Stocks: VTI, AGG
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