In 2019, I will make my third Required Minimum Distribution – RMD. For you youngsters, RMDs are required withdrawals from a tax-deferred account such as an IRA. They kick in at age 70.5. I am 72, so my first RMD covered 2017. Last year I made my second RMD, and this year will be my third.
RMDs allow the federal government to tax some of the money that you contributed to your 401k, traditional IRA, or similar account without ever paying income taxes on your contributions. RMDs require you to remove some money each year from the account and pay taxes on it.
The required amount to withdraw each year is determined by the IRS, and your withdrawals are taxed as ordinary income. Ordinary tax rates apply no matter how the money originated, whether it was your own contribution from salary, an employer match, dividends earned in the account, long-term or short-term capital gains, etc. No matter how it got into your account, it is ordinary income when it comes out.
For a complete article on how I viewed RMDs when I first became obligated to make them, please see Dave And Sue's Excellent RMD Adventure from 2017. In that article, I said this:
In the first few years, my IRA will have enough cash to cover the withdrawals. To get a head start on that, I stopped reinvesting some dividends over the past year to build up a small cash reserve that will help fund the first couple RMDs….
I intend to experiment the first couple of years with cash accumulation to see how everything works in terms of having the IRA portfolio generate enough cash to minimize or eliminate the need to sell any assets for the first few years.[Emphasis added]
My idea at the time was to not sell any stocks for the first several years, and instead to accumulate dividends, pile up the cash, and extract the RMDs from that cash pile.
I’ve changed my mind. Here’s why: I realized that the money accumulating in cash was just sitting there doing nothing, whereas if I simply invest it, it can generate “extra” income prior to when I distribute it to satisfy the RMD.
For example, this morning I invested accumulated cash of about $5000 (numbers changed to protect my privacy) in Main Street Capital (MAIN). That bought me 132 shares of MAIN.
MAIN pays dividends monthly, and their current payout rate is $0.195 per share per month (yield = 6.4%). So if I withdraw my RMD in, say, late November, I can own those shares for 9 months of dividends, which means that they will pay me $0.195 x 9 months x 132 shares = $231 before I let them go.
This assumes, of course, that MAIN maintains its payment schedule and does not cut the dividend between now and then. On the other hand, it also assumes that MAIN will not raise its dividend, and it also ignores MAIN’s history of paying a special dividend each June.
Thinking probabilistically, I put the probability at 80% that the shares I bought today will pay me at least $231 by the end of November. That strikes me as a good prop bet, so I took it.
Within my IRA, there are no tax consequences to either buying or selling the shares, or to receiving the additional dividends, just as there have been no tax consequences for any transactions within the IRA for decades. The only taxable event will happen later this year when I distribute the RMD to myself.
That’s what caused me to change my mind. I came to realize that the “don’t sell shares” goal for covering RMDs was an illogical goal. I can “rent” shares for short periods of time, make some money off of them, and then sell them back with no tax consequences to help me cover my RMDs.
In fact, I may choose to sell other shares and keep the MAIN shares. I already had a position in MAIN, but it was small. This purchase brings it closer to the size of many other positions in the account. If I choose, I can use these purchases during the RMD phase of my life to rebalance and improve the overall quality of my portfolio. Or I could start to drip everything to put the reinvestments on auto-pilot.
Or I can choose to leave it alone. It’s up to me. Doing it a few times doesn’t require me to do it forever.
Anyway, I thought that in light of the plan outlined in the earlier article, I would update you on this change in my approach. As always, I am describing what I have done and why I did it. It is not my intent to convince anyone that my choice would also be better for them. I have simply decided that it makes sense for me.
I look forward to your comments. Thanks for reading.
Disclosure: I am/we are long MAIN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.