Four Ways to Increase Client Income Systematic Withdrawal Plan - Part Two

There are four ways to increase client incomes.

•  Income-only Plan
•  Systematic/Partial Withdrawal Plans (SWP)
• Annuitization  
• Combination of SWP and Annuitization

I wrote Part One of Systematic/Partial Withdrawal Plans, and this is Part Two on that subject. So, we are still discussing the second alternative which is the Systematic/Partial Withdrawal Plan (SWP).  The client most suited to a SWP is a client who has a higher tolerance for risk, wants full control of their assets and does not want an Income-only Plan.

As a Financial Advisor, you know the rules on withdrawing money from retirement plans, but clients often don’t. While they know they need to do something, many clients don’t seem to realize that when they turn 70½ they must begin to withdraw money from QRPs as well as any IRAs, SEP IRAs, SIMPLE IRAs, or retirement plans of any sort with the exception of the Roth IRA.  Roth IRAs do not require withdrawals until after the death of the owner. [1] This mandatory withdrawal is known as the Required Minimum Distribution (RMD).

According to the Internal Revenue Service, you must take your first required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year after you turn 70½. Example: you turn 70 ½ in July of 2020. You can wait until April 1st of 2021 to take your first required minimum distribution, but you need to remember that you must take a second withdrawal by 12.31.21. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the second RMD by December 31 of the same year.” [2]

If your client fails to do this, then he or she will pay an excise tax to the Federal government of 50% of the amount they should have withdrawn but did not. So where does this fit with our Systematic/Partial Withdrawal Plan (SWP)? While there is a required minimum distribution, there isn’t a required maximum distribution. You can withdraw as much as you want over the annual RMD limit. This isn’t necessarily a great idea for most clients, so why would they do it?

If you have a client who is receiving pensions from several organizations, isn’t in great health, has assured income from pension checks but hasn’t saved a lot of money outside of their retirement plan, then taking more than the RMD could make sense. If they want to travel extensively or spend three months in Paris at an expensive hotel, then they can take more than their RMD.

Why would you do this? When you take out your retirement distributions, you pay income tax on that money. If you have a large sum of money in your retirement plans and a large sum outside of your retirement plans, you want to live on the income and/or capital from your retirement plans. The reason has to do with two key tax issues. When you take money out of your plans, you pay income tax. When your heirs take money out of the retirement plan you have left them, they will have to pay income tax.

But if you spend the money in your retirement plans and leave your assets outside the plan to your heirs, they will receive a step up in the cost basis of those assets. They will only pay capital gains tax on the gain from the date of your death, not the date you bought the stock. Thus, you can make an unofficial ‘tax gift’ to your heirs which will reduce their capital gains tax liability going forward. This isn’t a strategy for everyone, but for the right clients, it can be and should be their strategy.

Resources:

[1] https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

[2] https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#3

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Contributing Writer: Subject Matter Expert Charles McCain