Save Taxes in Retirement: How to Reduce your Required Minimum Distributions!
***Transcript***
Do you have a significant balance in your retirement accounts?
Are you aware that at some point in time, you're going to be forced to take withdrawals from those accounts, which will both increase your taxable income and related income taxes? If so, stay tuned because in this video I'm going be talking about six strategies you can use to help reduce your required minimum distributions or RMDs.
Hi! My name is JP Geisbauer founder of CenterPoint Financial Management. I'm a certified financial planner professional, a certified public accountant, and this channel is dedicated to helping diligent savers maximize their lives and minimize their taxes as they transition into retirement.
In the interest of full disclosure, I want to clarify that this video is focused upon Individual Retirement Accounts only. Retirement accounts can be confusing. There can be different rules for different types of plans. However, most plans can be rolled over into an IRA, which can provide some significant flexibility. Just make sure you discuss it with your financial advisor to see if that option makes sense for you.
Before I dive into the strategies, let me provide some framework around RMDs and individual retirement accounts. Once you hit a certain age, you're going be required to take distributions from your individual retirement account. In 2024, those distributions start at age 73. If you were born after 1958 those distributions will start at age 75.
Your RMD is calculated using the prior year's ending balance of your retirement account divided by your life expectancy factor. The way the life expectancy factor works, the older you are the larger your RMD will be as a percentage of your total balance. For example, if you're age 63 and have one million dollars in your IRA, your life expectancy factor would be 26.5, resulting in a required minimum distribution of just under $38,000. However, if you were 90 and had a million dollars in your IRA, your required minimum distribution amount would be about$80,000.
So, what are the general takeaways from this? The larger your account balance and the older that you are, the larger your RMDs will be.
So now that we know that what are some strategies to reduce your RMDs.
1. Take IRA withdrawals earlier.
You can take IRA withdrawals without an early withdrawal penalty as early as age 59.5. So, given that you're going to be forced to take RMDs sometime around age 73 or 75, you've got a good 14 to 16-year window where you can begin strategizing taking distributions from those accounts to reduce those required minimum distributions.
The conventional wisdom is that you should never pay taxes until you absolutely have to. But if you have a significant IRA balance, it may make sense to take withdrawals earlier so that you can reduce the RMDs once they eventually kick in.
2. Strategic Roth conversions
This is a similar concept to number one above where we're accelerating income to reduce the tax hit in later years. But if you don't need those proceeds for living expenses and you are going to invest those proceeds, then a Roth conversion would be an incredibly tax-efficient strategy.
Unlike standard investment accounts, activity in a Roth account is tax-free. Roth distributions are tax-free to you and the beneficiaries who may inherit your Roth account. Finally, you can do Roth conversions before age 59.5 without incurring that 10% early withdrawal penalty.
So, if you don't need the funds when taking withdrawals, a Roth conversion may make sense.
Now it's worth noting here that Roth conversions do not count toward s a required minimum distribution amount. So, the ideal scenario would be to do this before you are required to take RMDs.
3. Delaying taking Social Security
Strategies one and two involve accelerating income into earlier years. One way to possibly offset the accelerated income would be to delay claiming social security.
(I've done a video on the benefits of delaying Social Security so we won't go into too much detail here. But you can find a link to that video here.)
For the purpose of this video, you are able to claim Social Security between the ages of 62 and 70. Generally, the longer you wait, the higher the monthly benefit you'll receive.
So, as it relates to RMDs, perhaps it makes sense to wait till age 70 to claim Social Security. And, while you're waiting to claim Social Security, you can begin taking withdrawals from your individual retirement account to help you make the ends meet.
If done correctly, this strategy can do two important things. Number one, it can reduce your required minimum distributions. And, number two, it can increase the amount of your monthly Social Security benefit.
4. Manage the tax location of your assets
As I mentioned earlier, one of the most significant factors in your RMDs is your prior year's retirement account balance. And, as your investments grow in that account, the balance of your account continues to get larger. So, you may want to consider holding investments that won't appreciate as much as others.
Now, this can get a little wonky and is a little bit like peering into a crystal ball, but there are investments that historically appreciate more than others. Think of high-tech stocks like Apple and Nvidia compared to certificates of deposit or treasuries. When you have high-flying stocks in your Individual Retirement Account, all of that appreciation will eventually be taxed at ordinary income rates. And, in the meantime, these assets can cause your RMDs to increase significantly.
You may want to put assets that might appreciate significantly over time into a Roth account so the appreciation will grow tax-free. Or in a brokerage account where the appreciation of those assets will be taxed at capital gains rates, and may be subject to a step-up in basis upon your passing.
So maybe it makes sense to put slower-growing assets into your individual retirement account.
Again, you're going to want to speak with your financial advisor to see what makes the most sense for you.
5. Make qualified charitable distributions or QCDs
If you are over 70.5, and charitably inclined, then qualified charitable distributions or QCDs could be a fantastic opportunity for you.
This distribution must be made directly by your IRA trustee to the charitable organization. And the limit for 2024 is $105,000. Any amount donated will go towards satisfying your RMD. This is particularly useful for taxpayers who no longer itemize and no longer get a charitable deduction on their income tax return.
Suffice it to say, this is an incredibly tax-efficient way to address your required minimum distributions and contribute to a charitable organization you care deeply about.
6. Mega backdoor Roth contributions
One of the best way to reduce your future RMDs is to never have to be required to take RMDs in the first place. Roth accounts are never subject to taxable distributions, and the assets in the account grow tax-free.
One of the most efficient ways to get money into a Roth is via mega backdoor Roth conversion. If you are a high earner making more than you typically spend, and you invest the excess, then a megabackdoor Roth conversion may make sense for you. Unfortunately, not all employers offer this within their 401k plan. But check with yours to see if it is available. And if it is, consider taking full advantage of it.
These conversions have been on the congressional chopping block in the past, so they may not be around forever. If it makes sense for you and your employer offers it, try to take advantage of it before they go away.
So there you have it! 6 possible strategies to help reduce both your RMDs and the related income tax associated with those RMDs.
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Thanks again for watching, and I'll see you next time.
About the author:
JP Geisbauer is a Certified Public Accountant, a Certified Financial Planner ®, and the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. JP Geisbauer is dedicated to helping California-based business owners and executives transition into retirement. He has been quoted in many news outlets including Forbes, Newsweek, US News & World Report, MarketWatch, YahooFinance, CNN and NerdWallet.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.