Required Minimum Distributions (RMD) Retirement Strategies to Reduce Taxes

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Required minimum distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts, including traditional IRAs and 401(k)s, once you reach age 73. The amount you have to withdraw depends on factors including account balances across relevant accounts, your age and your life expectancy, as determined by the IRS.

This article will explain the strategies you can employ to reduce taxes owed from RMDs, including delaying retirement, making qualified charitable distributions and using tax-efficient investments. By employing these strategies you can reduce your RMD tax burden, more effectively manage your estate and be better equipped for a stable and profitable retirement.

Understanding How RMDs Are Calculated

Calculating your RMD correctly will ensure you make minimum distributions from your retirement accounts and aren’t subject to IRS excise tax. Required minimum distributions are calculated using factors including your retirement account balances, the original account owner’s age and life expectancy factor.

To learn your life expectancy factor assigned by age, find the correct life expectancy table on the IRS website based on whether you’re the original account owner, the spouse of the account owner or non-spouse beneficiary of the account. Once this factor is found, the basic RMD formula is your account balance as of December 31 last year divided by your life expectancy factor.

With this understanding of how RMDs are calculated, read on to learn the best RMD strategies to reduce related tax burdens.

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RMD Strategies To Reduce Tax Burdens

Delay Retirement

While original Roth 401(k) account holders are no longer required to take RMDs, traditional 401(k) holders still face tax burdens when they turn 73 and must begin taking RMDs. A strategy to delay RMDs for traditional 401(k)s from your current workplace is to delay retirement. If you are still working for the company that sponsors your traditional 401(k) plan and you don’t own 5% or more of the company, you can delay RMDs until you officially retire.

This strategy will reduce the number of distributions you must take and pay taxes on past the age of 73. Once you retire from your company, you must take your first RMD by April 1 the year after you retire and RMDs each year following by December 31. This strategy only applies to the 401(k) of the company you currently work for, so if you have separate traditional 401(k)s or IRAs, you must take RMDs on those accounts beginning at age 73.

Convert To A Roth IRA

Withdrawals from Roth IRAs are tax-free, making them attractive for savers who wish to benefit from tax-free growth on investment returns and reduce their tax burden in retirement. For holders of traditional IRAs who wish to reduce their tax burden or who otherwise wouldn’t qualify to contribute to a Roth IRA based on income limits, converting your traditional IRA to a Roth is an effective strategy.

To convert your traditional IRA to a Roth IRA, you should follow the instructions of your custodian to rollover your IRA or transfer funds to a new Roth IRA account. Custodians require different steps for this process, so seek out guidance or read their posted instructions to ensure a successful conversion.

Once the rollover is complete, you will need to pay income taxes on the amount converted in the conversion year. You can convert the full amount in your traditional account or just a partial amount to reduce the tax burden for that year.

Qualified Charitable Distributions (QCDs)

The qualified charitable distribution (QCD) rule enables IRA owners who are 70 ½ years old or older to donate up to $100,000 to a qualified charity each year and exclude the donated amount from gross income for that year. This year also provides tax benefits for those age 73 or older as QCDs count towards RMDs for that year.

QCDs reduce tax burdens by counting towards your RMDs, allowing you to not pay taxes on the amount, up to $100,000 for the year, on the normal amount you would normally have to withdraw and pay taxes on from your traditional IRA. If you are married, you and your spouse can take a separate QCD up to $100,000. Only donations toward qualified charities can count towards your QCD so ensure your charity of choice is eligible to receive tax-deductible donations.

Making Strategic Withdrawals

An effective strategy to reduce taxes for RMDs is to plan when you’ll take distributions and how much you’ll withdraw. For example, large withdrawals from your retirement accounts will push you into a higher tax bracket, so by only making the required withdrawal for the year you can ensure you stay within your tax bracket and don’t pay a higher tax percentage for the year.

If you withdraw more than the required amount for the year, your higher income can result in higher Medicare premiums so be cognizant of maintaining the right income level for the year to save on healthcare costs. This strategy also relates to Social Security benefits as a higher income can lead to Social Security payments being subject to taxation.

When considering how much to withdraw from retirement accounts, you should balance the need for retirement income with the taxes or costs that can result from higher-than-necessary withdrawals. Planning ahead, knowing the minimum distribution you must take and how much you need will help you optimize your RMD tax strategy.

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Using Tax-Efficient Investments

Investing in tax-efficient methods, such as municipal bonds or index funds with low turnover rates, can help minimize taxable investment income and possibly reduce RMD accounts. Municipal bonds are an attractive tax-efficient investment because interest income from these assets are often exempt from federal and sometimes state and local income tax, reducing your RMD tax burden.

Index funds with low turnover rates are often low fee and allow investors to gain exposure to broad swathes of stocks with ease but also help reduce taxable income. These funds have lower turnover rates than actively managed funds which results in fewer capital gains distributions and lowered tax liability.

In addition to these tax-efficient investments, you can boost returns and manage risk with diversified assets, including small-cap stocks and mid-cap stocks.

Work With An Estate Planner

Working with an estate planner can help you navigate all possible options to reduce RMD tax burdens. Estate planners specialize in retirement planning and can assist you with strategies like setting up a charitable remainder trust (CRT).

Estate planners can assist you with setting up a CRT, which is tax-exempt and enables you to donate investments to a qualified charity while still earning income from these assets for a certain period or life. With a CRT, your taxable estate can be reduced, appreciated assets can be sold without incurring capital gains, you can receive a tax reduction through the transfer of assets, and your RMD amount can be reduced because assets are transferred to the trust.

Estate planners can also help you build a comprehensive estate and tax plan, explore other trust options and strategies, and identify tax-efficient investments to add to your portfolio.

Staying Informed About Tax Laws

Staying up-to-date with changes to tax laws and regulations can help you identify new ways to possibly reduce RMD taxes. For example, the recent Secure 2.0 Act raised the age to begin taking RMDs from age 72 to age 73 starting in 2023. For retirees who hadn’t yet reached 73 in 2023, their timeline to take RMDs was pushed back allowing more years to not take distributions and pay associated taxes.

Changes to tax laws can also create new tax advantaged accounts or modify rules for existing accounts, presenting new opportunities to reduce RMD taxes. New tax rules can also present changes to tax treatment of investments presenting new opportunities for tax-advantaged investments to add to your retirement accounts.

To stay up-to-date with new RMD rules, you can follow the IRS website, particularly the RMD FAQs page, which highlights new tax regulation and its effect on RMDs from your retirement accounts. Forbes is another excellent source for updates to tax laws and their effects on retirement accounts such as new 401(k) contribution limits.

Bottom Line

In this article, you’ve learned the basics of calculating RMDs and how to effectively reduce your RMD tax burden. By delaying retirement, making qualified charitable distributions, planning strategic withdrawals and investing in tax-efficient assets, you can reduce RMD taxes and better ensure stable retirement income.

In addition to these strategies, staying aware of the latest tax laws and how they affect RMDs, and planning for retirement with an estate planner will help increase the likelihood of a financially stable future.

Required Minimum Distributions Retirement Strategies To Reduce Taxes