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I will be turning 68 soon and plan to wait to claim my Social Security at age 70 to maximize monthly benefits. I also plan to retire at the end of the year, if not sooner (i.e. in three months or less). Does withdrawing from my traditional IRAs (current balance is $215,000) to reduce income taxes on my RMDs outweigh the benefit of keeping those withdrawals invested and increasing tax deferral? I understand that if I withdraw amounts up to my standard deduction, those amounts will be tax free.
– Austen
Retirement withdrawals, Social Security benefits, required minimum distributions (RMDs), taxes… there are a lot of moving parts when it comes to making decisions about your retirement income. Reducing the amount of money RMDs apply to can help you minimize your taxes once they take effect. This can also help you avoid taxes on your Social Security benefits.
If you don’t need the money now but want to reduce RMDs later, one of the best moves may be to convert part of your IRA to a Roth IRA each year. This can help reduce required withdrawals in the future and allow your money to grow tax-free, although there may be tax implications for certain withdrawals. (A financial advisor can help you through the Roth conversion process and avoid potentially unwanted tax consequences.)
Delaying Social Security benefits until age 70 makes sense for certain people. Then you can receive the largest possible monthly payment. You can start collecting retirement benefits at age 62, but the monthly amount will be reduced by 30%.
For example, if your full retirement benefit is $2,000, your benefit at age 62 will be only $1,400. However, if you wait until age 70, you’ll get a maximum monthly benefit of $2,480.
However, there are some circumstances in which starting earlier may be more beneficial, such as:
• You need the money to make ends meet
• You are in poor health or have a shorter life expectancy
• You are completely done with work
• Your spouse has earned more and will postpone payment
Remember, there is no right answer that works for everyone, and you should do what makes the most sense for your family. (And if you need help planning for Social Security benefits, consider working with a financial advisor.)
Once you reach age 73, you must begin taking required minimum distributions – also called “RMDs” – from all of your traditional retirement accounts, including IRAs and 401(k)s. Your RMD is calculated based on your age, life expectancy and account balance according to the IRS Uniform Lifetime Table. If you have multiple IRAs, you must calculate the RMDs for each separately.
What happens if you don’t take RMD? The IRS will charge you a penalty tax of 50% of the amount you should have taken. If you correct this and take the RMD within two years, the tax rate could drop to 25% or 10% depending on the circumstances. (If you need help calculating your RMDs, consider consulting a financial advisor.)
Every time you withdraw money from a pre-tax retirement account, such as a traditional IRA, you pay income tax on that withdrawal at your tax rate. Once you’re over age 59.5, you won’t be hit with the 10% early withdrawal penalty, but the money will become part of your taxable income.
In theory, if your total taxable income including the IRA withdrawal does not exceed your standard deduction, you will owe no income tax. The actual answer depends on your entire tax situation, which can change from year to year.
There are a few things you can do now to minimize future RMDs and future tax bills.
One option is to take withdrawals from your IRA now to reduce the balance and reduce your future RMDs. That can also make it easier to wait until age 70 to receive Social Security, maximizing these benefits. The downside is that you’ll miss out on additional tax-deferred growth in your IRA and have a smaller savings pool to draw from later.
You can also convert some or all of your IRA to a Roth IRA. You pay tax on the converted amount, just as you would if you were to withdraw the money. But your money will continue to grow tax-free in the Roth account, which has no RMDs. As an added bonus, Roth withdrawals don’t count as taxable income, so they won’t affect taxes on your Social Security benefits. One caveat: Roth IRA conversions have a strict five-year rule. To maintain full tax-free status, you generally cannot make withdrawals for at least five years from the time of conversion.
Finally, if you don’t need the money from your IRA, you can donate your RMD directly to a qualified charity – a strategy called qualified charitable distributions (QCDs). This direct donation completely circumvents taxable income. If you want to make a donation, this is the way to do it. (If you have more questions about your future tax liability, consider speaking with a financial advisor.)
There are things you can do now to minimize your future RMDs, but each strategy will have a different effect on your overall financial picture. You can consider withdrawing money from your IRA, converting your IRA to a Roth account, or even donating your RMD to charity, eliminating your tax bill on the money in the process. Keep in mind that the option you choose may affect the taxes on your Social Security benefits.
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A financial advisor can help you plan RMDs and make other important decisions 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 interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Consider a few advisors before choosing one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.
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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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Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
Michele Cagan, CPAis a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Michele is not a participant in the SmartAsset AMP platform, nor an employee of SmartAsset, and she received compensation for this article.
Photo credits: ©iStock.com/Andrii Dodonov, ©iStock.com/mixetto
The post Ask an Advisor: I’m 67 and have $218,000 in an IRA. Should I start my withdrawals now to reduce future RMD taxes? first appeared on SmartReads by SmartAsset.
