Your Questions Answered; RMDs, Social Security Taxes, Income Annuities, and Dividend Reinvestment

Our topic on this episode of the Ready for Retirement podcast is about answering multiple questions that have been recently submitted surrounding RMDs (Required Minimum Distributions), Social Security Taxes, Income Annuities, and Dividend Reinvestment.

Questions answered: What are the best strategies to manage RMDs (Required Minimum Distributions)? How should I be determining when to collect Social Security and what can I expect from a tax perspective? When does an income annuity make sense? Should I be reinvesting dividends? What is the best approach for my individual situation? 

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Key Points

• Dividend Investing
  • Should I reinvest my dividends or take as cash?
  • Ensure you’re keeping the overall portfolio in balance and managing the taxation as efficiently as possible.
• Example
  • Let’s assume you have two funds and one fund pays a high dividend and one of these funds is focused on growth and capital appreciation.
    • Next, let’s assume the dividends being received go to cash and you’re living off of the cash dividends and the growth fund keeps on rising.
    • Over time, the growth fund will represent a larger and larger portion of your portfolio over time.
      • Perhaps you wanted a 50/50 allocation, but with the dividend paying fund, part of the return is growth, however a larger portion of the growth is dividends and if you’re living on the cash, you’re effectively going to get a much lower ongoing growth rate compared to the traditional growth fund.
    • Your portfolio allocation may become very different and the risk may become greater than what you initially intended.
  • Tax Example
    • Let’s assume on January 1st, there’s a dividend distribution and capital gain distribution that’s being reinvested and you want to withdraw funds on July 1st (assuming you have a positive return).
      • You may be able to sell specific lots, but you want to ensure when you go to sell an investment you’re avoiding any sale that avoids a short-term capital gain if at all possible.
    • From a returns perspective, whether you choose to reinvest dividends and rebalance along the way or have dividends paid as cash and choose which funds to reinvest to, it won’t matter too much which you choose as long as you’re aligning your portfolio allocation with your goals.
    • This only applies to non-retirement accounts.
  • If you want something that’s easy, I’d recommend reinvesting your dividends and rebalancing accordingly to ensure there isn’t too significant of a cash drag.
• Income Annuity
  • I use bonds to serve as a ballast and a place to draw income from when the market is down.
    • As interest rates rise, bond prices fall.
  • An income annuity is similar to buying a pension (single-premium immediate annuity).
    • An income annuity provides monthly income, but doesn’t allow for a proper portfolio allocation as it can often lead to excess equity exposure in retirement.
  • An income annuity with $250k will pay ~$12k/year or $13k/year and not provide additional growth over the long-term.
• When Should I Get An Income Annuity?
  • Income annuities often make sense if you can’t stomach the ups and downs of the stock market and a guaranteed income source.
  • You may find that you want to ensure your basics are covered and are comfortable with giving up potential returns knowing they will have certain expenses covered.
• RMDs (Required Minimum Distributions)
  • When do you have to take your RMD?
    • You can take your RMD in the year that you turn age 72 (and for each subsequent year).
      • It does not matter if you take it before or after your birthday.
• Roth Conversions
  • The more your AGI (Adjusted Gross Income) increases, the more your Social Security benefit may become taxable.
  • Provisional Income
    • This is a separate calculation that determines how much of your Social Security benefit is taxable.
    • Provisional income takes into account: wages, taxable and non-taxable interest, dividends, pensions, self-employment, other taxable income, and ½ of your annual social security benefit
      • If you’re single and the sum of all of these numbers is less than $25,000, 0% of your Social Security benefit is taxed.
  • Example: Let’s assume your single and your SS benefit is $30,000/year and Pension income of $8,000/year.
    • Your provisional income is $8,000 + $15,000 (½ of $30,000) and your provisional income is $23,000, which would mean you pay 0% in Social Security taxes.
  • Example: Let’s assume the same example, however you also take out $100,000 from your IRA each year.
    • Your provisional income is $100,000 + $15,000 = $115,000.
      • If your provisional income is $8,000 + $15,000 (½ of $30,000) and your provisional income is $23,000, which would mean you pay 0% in Social Security taxes.
      • If your provisional income is more than $23,000 and less than $34,000, 50% of your social security benefit is taxable.
      • If your provisional income is above $34,000, 85% of your Social Security benefit is taxable.
    • If your MFJ
      • If your provisional income is less than $32,000, 0% of your social security benefit is taxable.
      • If your provisional income is greater than $32,000 and less than $44,000, 50% of your social security benefit is taxable.
      • If your provisional income is greater than $44,000, 85% of your social security benefit is taxable.
  • These numbers have not adjusted for many years and haven’t been adjusted for inflation, thus the reason for the oddly low thresholds!
• Roth IRA distributions do not count towards provisional income
  • Example: Roth IRA distributions do not factor into your provisional income and since ½ of your Social Security benefit is calculated with provisional income, there’s a high likelihood you won’t be taxed on Social Security.
  • Roth Conversions are likely not worth implementing solely to limit taxation on Social Security, but they can be very helpful when implementing in relation to your overall financial strategy.

Timestamps

1:00 – We’re on YouTube!

3:40 – Reinvesting Dividends

6:03 – Short-Term Capital Gains

9:04 – Why Do We Own Bonds?

11:42 – Income Annuity v. Bonds

15:41 – RMDs (Required Minimum Distributions)

19:42 – Social Security Taxation

22:14 – Inflation

25:31- Aligning Your Investments With Your Financial Goals

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