Required minimum distributions (RMDs) require special attention. The rules surrounding how and when to take them are complicated and arcane, and taking RMDs creates a ripple effect throughout your financial plan that could set you up for some unpleasant surprises.
Those who have a significant portion of their assets in tax-deferred accounts (like 401(k)s, 403(b)s and traditional IRAs) are especially at risk. If your RMDs are large, you may find that you have more income than you need. It sounds like a great problem to have — until you realize that your RMD may bump you up in to the next tax bracket.
That not only has implications for your immediate tax bill, it also could impact how your Social Security benefits are taxed. Increasing your income can make up to 85% of your Social Security benefits taxable.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
And to follow the ripple even farther downstream, since Medicare Parts B & D premiums are based on your adjusted gross income (AGI) from two years prior to the year in which you pay your premiums, a higher AGI caused from RMDs could mean higher Medicare premiums, as well.
Here are four ways to reduce RMDs so you can avoid the ripple effects of excess income.
Draw down on IRAs before age 70½.
Once you turn 59½, you can withdraw your IRA funds sans penalty, regardless of your working status. Spreading your withdrawals out between ages 59½ and 70½ means that you get to spend money when you need and/or want it, and you won’t have to withdraw huge chunks of money later in life when you may not need the additional funds. Keep in mind that “no penalty” isn’t the same as “no taxes” — you’ll still be required to pay tax on those withdrawals.
Of course, there are smart ways to spend these withdrawals, but there are also some not-so-smart ways. Make sure your spending objectives are in alignment with your retirement and lifestyle goals. Will you spend that money on travel while you’re still able-bodied? Will you use it to purchase long-term care insurance? You need to make the choice that best fits your own retirement picture.
Execute a Roth conversion.
A Roth conversion allows you to move money from a tax-deferred account to a tax-free Roth account. You’ll pay income tax on the amount converted, but you won’t ever have to take RMDs from the Roth (at least according to current tax law). By proactively making Roth conversions, you’re able to lock in the tax on your tax-deferred savings today, rather than potentially paying a higher rate (on a larger amount!) in the future.
For example, let’s say you’re a single filer with $60,000 in taxable income and $800,000 in a traditional IRA. It may be advantageous to convert up to $31,000 of your traditional IRA savings into a Roth IRA to “fill up” your 25% tax bracket. You’ll be taxed at the 25% ordinary income tax rate now, but since the converted amount is now in a Roth, it won’t be subject to RMDs in the future. And you’ll enjoy all the typical benefits of a Roth account: tax-free growth and distributions.
For those building their financial plans with estate planning in mind, remember that any non-spousal beneficiaries who inherit a Roth IRA are required to take RMDs (spouses can avoid RMDs depending on how they take them), typically over their lifetime. The good news is that RMDs will continue to be tax-free.
Move your money to an employer-sponsored plan.
Still working in your 70s? If you own less than 5% of the company where you work, you may be able to delay taking RMDs from your pretax employer-sponsored plan until April 1 of the year after you retire. This also may allow more time to make Roth conversions.
Bonus idea: The super-savvy among us may use this opportunity to roll over pretax funds from old IRAs or 401(k)s into their pretax company plan if the plan will accept this type of rollover. This strategy is commonly referred to as a “reverse rollover,” and it could save you a bundle.
Maximize charitable gifting.
If you planned on giving your RMDs to charity because you don’t need the excess income, consider doing a Qualified Charitable Distribution (QCD) from your IRA. This provision allows you to donate up to $100,000 annually from your IRAs to the charity of your choice. The QCD counts toward your RMD requirement and helps to avoid raising your AGI, which, as we previously discussed, can help avoid Medicare premium increases.
The QCD allows you to potentially avoid unnecessary taxation, and your favorite charity gets more money. It’s a win-win.
The Bottom Line
Planning for RMDs is rife with complication. Make one misstep and you could be setting yourself up for years of expensive consequences. The earlier you plan for future RMDs, the better.
Ask yourself and/or your adviser the following questions to help you determine if your RMD planning strategies are fully sound:
- Do you understand the projected size and impact of RMDs to your situation?
- How does your RMD plan integrate and/or support the pursuit of your financial goals and objectives?
-
Top Five Tips From Current Retirees to Future Generations"Plastics" is no longer the wisdom passed down to the young, as in "The Graduate." These days, retirees are giving much better advice.
-
Three Simple Ways to Live Greener This Earth DayEasy upgrades that help you live greener, reduce waste and reconnect with the planet.
-
Four Takeaways From Filing Your Taxes to Boost Your Financial FutureNow that another tax season is in the rearview mirror for most of us, what lessons can you take from what you learned about your finances to plan for the future?
-
What Claims Adjusters Are Thinking vs What They're SayingAfter a natural disaster, few of us are at our best, but here's what to keep in mind when you're interacting with your insurance company's claims adjuster.
-
Looking to Make a Job Change? How to Stand Out Like a ProTo make a strong first impression in interviews or when networking, skip your job title and work history and use an opening gambit that highlights your talents.
-
First 100 Days: Trump's Impact on Your FinancesHere are some opportunities to consider regarding investing, interest rates and tax cuts as the financial landscape shifts under the new administration.
-
What Would Happen if You Put Your Tax Refund in an IRA?Not only could you get a tax break, but the compounding effect over 35 years could turn the average refund into nearly $14,000.
-
Children Can't Afford to Fly the Nest? Here's How to HelpThe high cost of living means more adult children are staying at home. Here are four ways to help financially so they can eventually spread their wings.
-
A QLAC Does So Much More Than Simply Defer TaxesHere are the multiple ways you can use a QLAC, from managing retirement risks to creating income for specific retirement needs and wants.
-
Self-Directed Brokerage Accounts: Retirement's Hidden Gem?SDBAs are often overlooked, but they can offer more flexibility and growth potential inside your 401(k) when actively managed by a professional.
