In the 1970’s the Employee Retirement Income Security Act (ERISA) created a new set of retirement strategies from 401(k)s to IRAs. Many of these retirement plans gave an individual the ability to defer taxes on contributions and growth that occurred within the retirement account until a later date in retirement. The Required Minimum Distribution (RMD) was also created and mandated withdrawals by the original account owner. Then, after that person dies, anything remaining in an IRA would be withdrawn by his or her heirs. All of these required withdrawals are considered taxable income – no matter who takes the distribution.
The rules surrounding RMDs have changed multiple times since their inception but currently (as of 2023), the first required minimum distribution must begin at age 73 (actually by April 1st of the following year) and starting January 1, 2033, RMDs will begin at age 75.
Retirees that have utilized retirement accounts for decades now find themselves at a point where they must manage their withdrawals. While many retirees utilize their RMDs to support their lifestyle, some individuals and couples are seeking guidance on how best to manage the taxes associated those RMDs.
Let’s take a look at some unique planning strategies to strategically manage your RMDs.
Roth IRA Conversions
Over two decades after the original IRA & 401k were created, Senator William Roth introduced the Taxpayer Relief Act of 1997 that introduced the Roth IRA. Roth IRAs offer the benefit of 100% tax-free qualified withdrawals, and they don’t have RMDs. If you’d like to reduce or avoid RMDs, you could convert your traditional retirement funds to a Roth account. You’ll have to pay tax on the conversion in the year it occurs.
Let’s consider an example. Barbara and Jim are retiring at age 65 and are planning to hold off on taking social security until age 70. Barbara and Jim have done well saving and have $1 million in a brokerage account and $1 million in traditional IRAs. Since Barbara and Jim will have no earned income and minimal taxes from their brokerage account they plan to convert $100,000 each of the next 5 years to take advantage of paying taxes in the 0%, 10% and 12% brackets.
These Roth Conversions will reduce future RMDs for the couple and help manage their taxable income later in retirement.
Consider Taking IRA Distributions Early
There are two options here. Under most circumstances, distributions from an IRA can begin at age 59 ½ without penalty. Some couples are in the unique position to retire early. Since social security will not even be a consideration for 3 years (and more likely 5-10 years), it may make sense to begin taking distributions from your retirement accounts rather than brokerage accounts to take advantage of the current low tax brackets.
A second, less know option are called 72(t) distributions from IRAs. Now let me be up front that 72(t) distributions are quite complex and need to be handled carefully with your advisor and certified public accountant. But if handled correctly 72(t) distributions allow for no penalty on IRA distributions at any age. 72(t) distributions require Substantially Equal Periodic Payments that must last until at least 59 ½ or 5 years; whichever is longer.
Power Up Your Donations to Charity
A qualified charitable distribution (QCD) allows individuals who are 70½ years old or older to donate up to $100,000 total to one or more charities directly from a taxable IRA instead of taking their required minimum distributions per year.
The value here extends beyond reducing income tax. Many couples today experience multiple negative effects from higher levels of income in retirement. Utilizing QCDs could help avoid the Medicare 3.8% surtax. Additionally, QCDs could help reduce or avoid the surcharge applied to Medicare Part B & Part D premiums called income-related monthly adjustment amount (IRMAA).
Check Your Beneficiaries
If you’re at least 10 years older than your spouse and name them as the sole beneficiary of your retirement account, you can use a different potentially more favorable calculation for RMDs. This strategy allows you to use your spouse’s longer life expectancy to determine how much to withdraw for RMDs, which can lower the amount. But if you have multiple beneficiaries, you wouldn’t be able to use this RMD strategy.
The nuances surrounding Required Minimum Distributions make a seemingly simple decision quite complex! Advanced retirement planning can dramatically change RMDs for a client and the corresponding taxation. Your advisor(s) at Innova are excited to help navigate these strategies!
INNOVA is a SEC registered investment adviser. Information presented is for educational purposes only intended for a broad audience. INNOVA is not giving tax, legal or accounting advice, consult a professional tax or legal representative if needed. The opinions expressed herein are those of the firm and are subject to change without notice. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Any opinions, projections, or forward-looking statements expressed herein are solely those of author, may differ from the views or opinions expressed by other areas of the firm, and are only for general informational purposes as of the date indicated. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.