Caller Paul is about to hit 70½ and wants to know if he should reinvest his required minimum distribution, or pay off his mortgage.
Scott: Paul, you're with Hanson McClain's Money Matters.
Paul: Hey Scott.
Paul: Enjoy your program always, really.
Scott: Well thank you. How can we help you today?
Paul: Well, I'm turning 701⁄2 in a few days here, and the required minimum distribution is coming up. And what I'm concerned about is what to do with this money. I don't have a real need for it right now, and my wife is going to be in the same boat here in about a year and a half. And you know, we've got enough money. I work right now as an independent consultant after I retired from the military, and so I'm trying to figure out a smart way to invest this money in an IRA.
Paul: I think the sooner, the better.
Scott: If you are an independent consultant, are you self-employed there?
Scott: How much do you have, ballpark, in your retirement plan?
Paul: In my IRA I've got about $300K.
Scott: Okay, and how about your wife?
Paul: About the same.
Scott: And how much longer do you think you'll do some part-time consulting?
Paul: Till I'm not able to do it. I enjoy it a lot.
Scott: You know, it's interesting. We hear more and more from people at your stage in life that are continuing to work. Doing some sort of work because you enjoy it, and you find engagement and purpose and meaning. So if this wasn't your company, say you worked for somebody else, you could take your retirement plan, roll it into the company's 401K and delay distributions until you actually retired. And I started going down that path, then I realized that there's a provision that says if you're more than a 5 percent owner, it's not going to work for you. So forget about that.
So you're kind of stuck with having the taxable distribution, and it's about roughly 4 percent or so. There's going to be about $11,000 that's going to be taxable to you this year whether you like it or not. Technically you've got until April 1st next year to take your first distribution. If you waited until next year though you'd have to take two distributions. Should be about $22,000 next year, so you probably don't want to do that.
What a lot of people do in your situation is just simply set up an account at whatever firm you have your IRA. Set up a brokerage account, and have that dollar amount just transferred over to that brokerage account and have the taxes paid along the way. So let's say if it's $11,000, maybe you've got 25 percent that is going to go to taxes. You have the 25 percent automatically sent to the taxman. Have the rest of the dollars go into your brokerage account and keep them invested that way.
What we typically recommend however is when you've got money that is outside of the retirement account, you want to pay attention to the taxation of that. So let's go out 10 years from now. Maybe you're going to continue working as a consultant for the next 10 years. Sounds like you might, right? I mean people are living longer and longer, and if you're enjoying it, and as long as you've got your health...So it could be many, many years, and as we start drawing down the IRA and building up investments on the outside you want the most tax efficient investments possible. And let's say your portfolio has some portion of stocks and some portion of bonds, what I would recommend is to have the most tax efficient stock portion of your portfolio, have that portion distributed. So let's say it's $11,000 you have to take out. Have that $11,000 in a brokerage account, but maybe have that invested, just as an example, in a S&P 500 index fund.
It's going to spin out very little in the way of taxable dividends and capital gain distributions. Then adjust your IRA so that you take that into consideration. So maybe have slightly less equities in your IRA.
Scott: Does that make sense?
Paul: Yeah it does. My IRA is based on the S&P 500 index fund as it is. Another thought.
Scott: A 100 percent of it is?
Paul: Well a good bit of it, yes.
Scott: Wow. I mean long term that's probably going to give you the greatest results, but most people can't stomach the ups and downs of it.
Paul: Yeah, well you know I've always looked at the long view. Historically the stock market has done very well, and I'm not real interested quite frankly in adding to that. But here's another thought I wanted to run by you. We built a brand new house about 10 years ago, and we've got about eight years left on the mortgage. And I was sort of thinking about putting money against the principal.
Scott: Well, yes and no. Normally I'd say that’s a “no brainier.” Absolutely do it. But considering that you're 70 years old and you've owned stocks for a number of years, and you've got confidence, if we look long term you're probably going to be better off owning the S&P 500 index fund over paying down that mortgage.
Paul: Mm-hmm. Yep.
Scott: But if you're thinking that your consulting job will end, then I do like the idea of taking your RND and just socking it against the mortgage. Because you're already paying taxes on it, right?
Scott: So if you like the idea of having your home paid off, then I say that's a great thing to do because you're stuck taking that money out of your IRA. But you're really not stuck selling stocks. So if it turns out that you're going to take your required minimum distribution the latter part of this year, you can still maintain your stock exposure. You're not necessarily forced to sell the stocks. You're just forced to get the securities outside of the IRA.
Paul: Yeah. Well, what I was hoping to do is maintain liquidity, and if for some reason my health went south and I stopped doing consulting then I wouldn't have to continue on with paying against the principal of the mortgage. And you know, I could use that money to do whatever I needed to do with it. We normally keep around $20,000 in liquid funds.
Scott: Well, I'm personally a fan of having a home paid off in retirement. I think for most people it just takes some stress away. In a marriage there’s usually one person that is pretty adamant about having it paid off. And my experience is I've never seen anyone upset that they paid their house off. Is your goal to have some financial peace? Then I like the concept of having the required minimum distributions come out and applied to the mortgage.