After age 72, a Required Minimum Distribution (or RMD) must be withdrawn from your traditional IRAs and 401(k)s each year—whether you need it or not.
Failing to take an RMD could result in a tax penalty worth up to 50% of the amount you should have taken.
Listen now and learn about seven strategies to minimize the RMD tax liability.
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Show Notes
There are almost 75 million Baby Boomers in the U.S. today and approximately 10,000 of them retire each day. That’s a lot of potential people taking required minimum distributions who may not need them.
After age 72, a Required Minimum Distribution (or RMD) must be withdrawn from your traditional IRAs and 401(k)s each year—whether you need it or not.
The funds you receive are treated as ordinary income and can even push you into a higher tax bracket.
But even if you’re someone who doesn’t need those RMDs to meet living expenses, failing to take an RMD could result in a tax penalty worth up to 50% of the amount you should have taken.
Many of our clients at Plancorp face this situation every year, but there are several smart moves you can make to minimize the RMD tax liability.
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In the meantime, here are seven strategies to consider if you don’t actually need your RMD to meet living expenses:
1. Consider a charitable contribution.
When you direct your RMD to a charity, it becomes a qualified charitable distribution, or QCD, which is no longer considered taxable income. Although RMDs don’t start until age 72, IRA owners who are at least 70 ½ may transfer as much as $100,000 directly to charity each year, tax-free.
This is an especially good use of your RMD if you take the standard deduction and wouldn’t be able to write off charitable donations.
A QCD also provides a higher dollar-for-dollar tax benefit compared to a donation of cash or appreciated securities from someone who can itemize because it directly reduces adjusted gross income (AGI).
2. Convert into a Roth IRA.
If you own a Traditional 401(k) or IRA—both of which have RMDs —consider rolling the money over into a Roth IRA, which has no RMDs for the original owner.
Keep in mind that you’ll still have to pay taxes on the amount being rolled over from an IRA. And, if you’re already 72, you’re required to take your RMD before converting. On the plus side, converting doesn’t need to be done all at once. You can roll a portion each year to manage the tax liability, which will also reduce the RMD until all your funds are converted.
This strategy works best if started in the early years of retirement prior to taking Social Security or RMDs, but the math on a partial Roth conversion can still make sense for some people at age 72 and beyond.
If you’re still working and not greater than a five percent owner of the company, you could also roll an IRA into a 401(k) where RMDs are not required until you retire.
3. Reduce your taxed amount.
If you have company stock in your 401(k), consider rolling the non-stock portion of it into a traditional IRA and transferring your employer stock to a taxable brokerage account.
That way, ordinary income tax will be due on the stock’s cost basis, not its market value.
Of course, any unrealized appreciation is taxed as a long-term capital gain when the position is sold. Going forward, you’ll still have RMDs on the balances in the traditional IRA, but they’ll be much lower without your company stock in the account.
4. “Lengthen” your life expectancy.
If your spouse is more than ten years younger than you, their longer life expectancy can be used to reduce your RMD.
You can refer to Table II of IRS Publication 590-B to calculate the subsequent impact on your taxes. If you’re 76, for example, and married to a 62-year-old and your IRA was worth $1,000,000 at the end of 2022, your RMD would drop more than 11 percent to about $42,194.
5. Account for your nondeductible contributions.
Any nondeductible contributions made to your traditional IRA are not subject to further taxation when removed from your qualified retirement account.
The suggestion here is to keep good records of these amounts to figure out the ratio of your nondeductible contributions to your entire IRA balance. That way, you can reduce the tax bill on your RMD.
6. Transfer to a different account.
RMDs do not have to be made in cash. You can direct your custodian to transfer shares to your taxable brokerage account instead. While the distribution will still be taxed, any further appreciation in the asset will be subject to capital gain taxes when sold, which are charged at a lower rate than ordinary income taxes.
Candidly, I’m of the opinion that if you go this route you are actually better off simply liquidating some of your holdings and moving to the seventh item, which is…
7. Invest for growth.
Consider redirecting your distributions into investments that will continue to appreciate over time.
When it comes to RMDs, it can literally pay to know the rules and your payment expectations.
Retirement is a time for relaxation, not financial stress. So, spend time planning with your financial professionals to maximize your retirement savings—and then enjoy the fruits of your labor.
Next Steps…
If you’re ready to start making smart decisions with your money and build your wealth, here are a few other resources you may find helpful:
- Take my financial wellness assessment and learn in just 9 questions the biggest areas of opportunities you should focus on in your finances.
- Download the free worksheets and checklists I have that will help you set your financial goals, decide if you should rent or buy a house, and many other important financial decisions.
- If you think having an advisor who can guide you through making a plan, reducing your taxes, and other important decisions around your retirement would be helpful, let’s chat. I may be able to give you the help you need.
Resources
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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