In last week’s blog post I covered the basics of how required minimum distribution (RMD) rules work for IRAs and other tax deferred retirement accounts. To summarize you must take out a minimum amount from your account each year. That’s RMD and it starts in the year you turn age 70 and ½.
If you have more than one IRA you don’t have to take out a proportional amount from each account. You total all your IRA balances and calculate the RMD. As long as you withdraw at least that amount from any of your retirement accounts, the IRS does not care which ones. In other words, you can withdraw your RMD all from one account and nothing from another as long as the total withdrawn is at least the minimum.
And what happens if you don’t withdraw enough? The IRS assesses a pretty hefty 50% penalty on the amount you should have withdrawn but didn’t. (and of course, you still have to withdraw the rest of your RMD.)
Many people are reluctant to withdraw more than their RMD because they know they will have to pay 35 to 40% in federal and state income taxes on most of the money withdrawn from these accounts. As I always remind clients, if you have $500,000 each in an IRA and a regular taxable account, they are not worth the same. The IRA is worth approximately 35 to 40% less because income tax has not yet been paid on the growth in the IRA each year as has been paid on the taxable account.
However, I often advise clients who need long term care that using their IRA money to pay for care can often be a smart move even if it means taking more than the RMD. That’s because those clients will very likely have increased medical deductions on Schedule A of their income tax returns. These deductions can offset some or perhaps all of the tax that would otherwise be owed on the withdrawals. . (You should always check first with your tax professional.) In some cases that $500,000 IRA could really be worth $500,000 after tax.
There are also ways to maximize the use of your IRA for long term care when you are still healthy and don’t yet need the care. It’s something I wrote about on this blog back in 2015. (See posts 6-29-15 thru 7-13-15). IRA funds can be moved to a life insurance policy/annuity that also covers long term care. Because the annuity is still an IRA no withdrawal occurs and no tax is paid now. If long term care is needed, then the annuity will pay for the care. If no care is needed the account balance is transferred under the life insurance policy to the designated beneficiaries. Another added benefit is that some products allow one spouse’s IRA to cover both spouses’ long term care. This is especially important when, for example, one spouse cared for the children and did not work outside the home for many years.
As we see more clients coming thru our doors who have a majority of their savings in retirement accounts, planning for long term care is a bit more challenging because of the tax issues, however, there are some good options available to those who seek out the right professional advice.