Required minimum distributions (RMDs) are the mandatory withdrawals that the Internal Revenue Service (IRS) says you must take from your tax-deferred retirement accounts, such as traditional IRAs and 401(k)s once you reach a certain age. That age has always been 70 ½ for a long time, but the SECURE ACT 2.0 changed the distribution ages as follows:
- If you turn 72 after 2022 and 73 before 2033, you start taking RMDs at 73.
- If you turn 74 after 2032, you start taking RMDs at 75.
The key to savvy RMD management is minimizing your overall tax impact. Many savers max out pre-tax retirement plans during their working years. While this seems like the right thing to do, it can come at a big tax cost. While the IRS doesn’t make you take it out until 73 or 75, you can certainly take it out as early as age 59 ½ without any penalties.
4 of the Best Strategies for Reducing RMDs
1. Begin withdrawals from your tax-deferred retirement accounts as soon as you retire.
With people opting to retire earlier and earlier these days, this also meets cash flow needs. This will reduce the size of the pre-tax retirement account, and the corresponding future RMDs. Even if you don’t need all of the distribution for current living expenses, you can let it grow in a brokerage account. You will only pay long-term capital gains tax (at a much lower rate) instead of ordinary income tax on future growth.
2. Convert some traditional IRA money to a Roth IRA.
During little or no income years in early retirement, convert some of your traditional IRA balance to a Roth IRA. Again, this helps smooth your tax burden and takes advantage of low tax bracket years. Plus, Roth IRAs do not have RMDs, so by converting some of your traditional IRA money to a Roth IRA, you can help reduce your overall RMDs.
3. Work longer.
If your situation permits, working longer can help you reduce your RMDs by delaying the start of your withdrawals.
4. Donate to charity.
Each year you can use up to $100,000 of your RMD to make a qualified charitable distribution (QCD) from your IRA directly to a qualified charity. The QCD is not taxable, so it saves you on taxes, allowing for a bigger gift to charity.
The optimal strategy for you might be one or a combination of these strategies. Check with a fee-only financial advisor to look at your financial plan and determine what might be best in your own unique situation.
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