Scott Burns: Bonding with interest rates; dealing with RMDs
Readers ask for advice on bonds and required minimum distributions (RMD).
Q: I have two questions about bond investments.
First, with individual bonds, would a person be better off keeping the bonds to maturity when rates went up and receiving the full value at maturity? Or should he sell and reinvest in higher interest-rate bonds?
Second, does this work with bond funds? Do fund managers hold bonds to maturity, or do they generally sell and reinvest when interest rates are going up?
A: On highly liquid and secure issues such as Treasurys, the market adjusts the price of the bonds so that the discounted present value of an older, lower-coupon obligation would be identical to the present value of a new bond with a higher coupon.
Some of the damage done to lower-coupon bonds in a rising-rate market is reduced by reinvestment of the coupons at the new higher rates.
Basically, it’s a toss-up, but some managers realize and use the capital losses. You can learn the basics in the classic “Inside the Yield Book” by Sidney Homer and Martin L. Leibowitz, first published in 1972.
Q: I have some questions regarding limits on required minimum distributions (RMD).
I am a 70-year-old divorced female. I retired late last year. In January I set up monthly RMD withdrawals to meet my obligation for 2013.
The total value of my account rose by nearly $8,000 during the first quarter of 2013.
I think at some point my RMDs are legally obligated to empty the SEP IRA account.
In the event I should be able to continue growing the account balance while making future RMDs, could I continue to invest?
If that is permissible, will I be required at some point in the future to move all the remaining funds to a taxable account?
A: You have no cause for worry. Many people have had the good fortune to make their retirement accounts grow even as they are taking required distributions.
It’s pretty easy at the start. The initial withdrawal rate is only 3.65 percent. But the rate climbs every year.
Sooner or later it will be well beyond any reasonable expectation of annual gains. When that happens, the account will start to shrink.
Most people who take RMDs will die with money in their accounts because they will die before the RMDs are so large that their accounts shrink rapidly.
This calculator doesn’t account for the ups and downs of the stock market, but by putting in different annual returns you can see how the RMDs eventually start to diminish the account.
You will never be required to do anything but take RMDs. The only raw spot here is that if you build the account enough, the rising RMD percentages will eventually force you to take more taxable income than you need. They may also put you into a higher tax bracket. Lots of people grind their teeth about this, but this is a nice problem to have.
Copyright, 2013, Universal Press Syndicate