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Anyone with a 401(k), traditional IRA or similar tax-deferred retirement account will eventually face the requirement to start taking required minimum distributions (RMDs) from their accounts. The IRS has made it so that you can have decades of tax-free growth in the account, along with years of tax deductions, so they eventually require you to start paying those taxes whether you need the money or not.
Starting at age 73 in 2024 (the RMD age goes to 75 in 2033), the law says you must withdraw a certain amount each year, and this is based on how the IRS sees your life expectancy. If you don’t take your RMD, the penalty is as much as 25% of the amount you didn’t withdraw (can be reduced to 10% if corrected within two years).
Do you have questions about planning for RMDs? Talk to a financial advisor today.
For someone who doesn’t need the money from an RMD to cover living expenses, the issue becomes not just what to do with the money, but how to minimize taxes. This is important because RMDs can lead to a number of different tax increases over your lifetime.
For example, you will first have to pay taxes on the withdrawal as ordinary income. Depending on the amount of your RMD, you could then have enough total income to impose taxes on up to 85% of your Social Security benefits. Higher income can also increase your Medicare premiums, which are subject to an IRMAA (income-based monthly adjustment amount) surcharge.
There are a few strategies you can use to minimize or avoid taxes on your RMDs, including the following:
The simplest approach is to donate some or all of the money to a qualified charity like Qualified Charitable Distribution or QCD. In this case, you never touch the money because it goes directly to the charity, meaning you don’t have to pay taxes on the donation. This only works if the money is sent directly to the charity (you can’t withdraw it and then donate it yourself) and you must also make sure the charity complies with IRS rules to be considered qualified. The IRS limits QCDs to $105,000 for 2024.
If you are still working and have a 401(k) with your current employer, you do not need to take an RMD from that account, and only from that account. This could be a good reason to roll over money from previous 401(k)s to your new employer’s plan, rather than to an IRA. Otherwise, you’ll have to take a taxable RMD from each of those older 401(k)s.
You can use up to $200,000 in distributions from IRAs or 401(k)s to purchase a Qualified Longevity Annuity Contract (QLAC). If you do this, the money you use for the purchase will be deducted from your taxable income for the year. The catch is that the IRS requires you to start receiving taxable payments from the annuity when you turn 85, so this eliminates your taxes, but only for 12 years if you start taking RMDs at age 73.
Do you have questions about planning for RMDs? Talk to a financial advisor today.
You may be able to offset the tax burden of an RMD by reinvesting the money in a Roth IRA, provided you have enough earned income (doesn’t have to come from a paycheck) to cover that contribution amount. So, for example, if you want to contribute $6,000 from your RMD after you withdraw it and pay taxes on it, on paper you need at least $6,000 in earned income to cover it.
You can then reinvest that money in a Roth IRA and avoid taxes on the gains the money makes, since a Roth IRA is an after-tax account. However, the account must be active for five years after the tax year in which you first contribute to it before withdrawals are actually tax-free.
Finally, you can invest the money in a taxable investment account and hold these assets for more than a year so that any gains qualify as long-term capital gains. These offer lower tax rates from 0% to 20% depending on your tax bracket.
Consider consulting a financial advisor to create an appropriate investment strategy.
You may also consider using the money to hire an estate planner or attorney to create a plan and strategy that will minimize taxes for you and your heirs, if you leave money behind. Similar to investing an RMD, you pay taxes on the money now, but you can use it for an estate plan that indirectly reduces taxes.
If your spouse is younger than you and has not yet reached the age to take RMDs, do not include these bills in your RMD calculation. The “I” in IRA stands for “individual,” meaning there are no joint RMD considerations until you are both old enough to take RMDs.
If your spouse is more than 10 years younger, you can name him or her as the sole beneficiary of your retirement account, which will allow you to calculate your RMDs based on your spouse’s longer life expectancy, as described in the IRS Joint Life and Last Survivor Expectancy Table.
A financial advisor can help you create a robust plan for 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 have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Don’t forget Social Security when creating your retirement income plan. SmartAsset’s Social Security Calculator can help you determine what you might receive in retirement.
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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