If you’re taking a required minimum distribution from an IRA, 401(k) or other tax-deferred account and don’t need the money to cover living expenses, where should you stash that unnecessary money?
Investors must now start taking RMDs at age 73, or, if born after 1960, at age 75. Depending on the balance in your accounts, that benefit could be a significant amount of money, perhaps more than you need to live on. One option is to reinvest that money, and a Roth IRA seems like a perfect choice: Withdrawals from Roth accounts are tax-free — including any gains on your investments — and you never have to take one of those pesky RMDs in your lifetime.
There’s just one problem: You can’t convert your RMDs directly into a Roth. But for some people there is a possible solution. Before 2024, you can contribute a maximum of €7,000 plus another €1,000 if you are at least 50 years old – if you have enough earned income.
Get matched with a financial advisor to discuss your own retirement strategy.
The IRS defines earned income as money you get for working, such as wages, commissions, bonuses, tips and honoraria for speaking, writing or participating in a conference or convention. Income generated through self-employment also counts. Income that does not qualify includes taxable retirement payments, interest income, dividends, rental income, alimony, and withdrawals from Roth IRAs or other non-taxable retirement accounts, along with annuities, Social Security benefits, unemployment benefits, workers’ compensation payments and your Social Security income.
Another limitation on Roth contributions is the income limit. Once your modified adjusted gross income (MAGI) reaches $146,000 for a single filer or $230,000 for joint filers, your maximum Roth contribution phases out to $161,000 (single filers) or $240,000 (joint filers). After that, you are no longer eligible for a contribution.
You should also remember that after your first contribution to a Roth account, you must wait five tax years before you can withdraw any money. Heirs who inherit your Roth must withdraw the entire balance within 10 years.
Consider talking to a financial advisor to develop a tax-efficient retirement strategy.
If you don’t qualify for a Roth contribution, you still have the option to eliminate, reduce, or defer your RMDs.
Roth conversion: You can convert your IRA to a Roth account once you have withdrawn your RMD for the year. You pay taxes on the amount you convert, so one tactic is to convert the maximum amount available without pushing yourself into a higher tax bracket. Each Roth conversion has its own five-year rule.
Charitable contribution: You can use a qualified charitable distribution to donate some or all of your RMD to an IRS-recognized charity. No tax will then be levied on the amount donated. To qualify, the funds must be transferred directly from your IRA to the charity.
Keep working: Your 401(k) account with your current employer is not subject to RMDs if you are still on payroll. One tactic is to roll 401(k)s from previous employers into your current plan so they are not covered by RMDs. However, once you stop working, RMDs are required.
Be careful: The penalty for not taking an RMD for the required period is significant – up to 50% of the missed RMD amount.
A financial advisor can help you navigate the specific risks and tradeoffs in your situation.
Structuring your retirement withdrawals to reduce your tax burden means looking at all your sources of income, including retirement accounts, RMDs, Social Security benefits, pensions and taxable investment income. For some people, withdrawing money from an IRA early in retirement can reduce the size of their eventual RMDs. If they also delay collecting their Social Security benefits, their benefits will increase by 8% every year until they reach age 70. Also be sure to coordinate taxes, withdrawals, and RMDs between spouses, and remember that a younger spouse’s RMDs do not need to be taken until he or she reaches age 73 or 75.
Other common retirement tax steps include investing in tax-exempt bonds, moving to a state with no income or estate taxes, harvesting tax losses in taxable investment accounts, and holding taxable assets long enough to qualify for lower long-term tax rates on capital gains. .
To learn more about retirement planning and how to work toward your goals, contact a financial advisor for free.
Managing your RMDs – and any other tax questions that may arise in retirement – ​​can be complicated. Take the time to estimate your retirement taxes before you start collecting pensions, Social Security and taking withdrawals from retirement accounts.
Balancing taxes and retirement income – and figuring out how to minimize taxes in retirement – ​​is a crucial issue. A knowledgeable financial advisor can help you decide how to structure and coordinate these payments during your retirement.
Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can interview your advisors for free to decide which one is right for you.
Make sure you protect your cash reserves against inflation by securing them in an account that generates a competitive interest rate. Leaving cash in a checking or savings account with a low yield can erode your purchasing power over time.
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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