The Smart Retiree's Guide to RMDs: Tips, Tricks, and Tax-Saving Strategies
Picture this: You've spent decades carefully saving for retirement, making all the right moves with your 401(k) and IRA contributions. You've watched your nest egg grow, feeling good about your financial future. But here's the thing — knowing how and when to take money out of these accounts is just as crucial as knowing how to put it in. That's where Required Minimum Distributions (RMDs) come into play, and believe me, they're a bigger deal than most people realize.
Why? Because mismanaging your RMDs can throw a major wrench in your retirement plans. They can impact everything from your tax bracket to your Medicare premiums and even affect how much your Social Security benefits are taxable. Plus, with the recent changes in RMD rules (thanks to various legislative updates), staying on top of these requirements has become more critical than ever for your overall financial health.
Think of RMDs as the grand finale of your retirement savings journey. You've done the hard work of saving and investing — now it's time to ensure you're taking distributions in the most innovative way possible. Getting this wrong could mean paying unnecessary taxes or facing nasty penalties, which we'll discuss later.
What is an RMD?
RMDs are the government's way of saying, "Hey, remember all that money you've been squirreling away tax-free in your retirement accounts? We are ready for that tax revenue now."
RMDs are the minimum amount you must withdraw each year from your retirement accounts once you reach a certain age. This applies to your traditional IRAs, 401(k)s, 403(b)s. 457 plans, etc. – all the various retirement accounts you've fed over the years with tax-deferred money. It's important to note that RMDs also apply to employer plan Roths – Roth 401(k), Roth 403(b), and Roth 457. RMDs do NOT apply to Roth IRAs.
Who Needs to Take RMDs? (And when?)
Here's where things get interesting. If you were born in 1951 or later, you must start taking RMDs at age 73. And if you were born after 1960, you must wait until age 75. Lucky you!
Here's a fun little loophole: If you're still working, you can delay RMDs from your employer's retirement plan (unless you own 5% or more of the company). However, you can only delay RMDs from your current employer plan. If you have various retirement plans, you must take RMDs from the company plans you are not working at.
The Math Behind the RMD
Calculating your annual RMD is pretty straightforward. At KWB, we created our own tool to ensure that all clients' RMDs are met, regardless of the complexity of their situation.
To calculate:
- Look at your account balance from December 31 of the previous year
- Find your "life expectancy factor" in the IRS table
- Divide the account balance by your life expectancy factor, and voila!
If you have multiple IRAs and retirement accounts, calculate the RMD per account or sum up account balances to calculate your total RMD. Once you have the RMD amount, you can take your entire RMD from one account or mix and match — whatever you want. The only thing the IRS cares about is that you took the amount that you were supposed to; they don't care which retirement accounts you take it from.
Deadlines Matter (Like, Really Matter)
Mark your calendars for December 31 each year — that's your RMD deadline. One caveat — for your very first RMD, you get until April 1 of the following year. Word of caution, though: if you delay that first one, you'll take two RMDs in the same year. You might delay because you don't need the money, but your tax bill might be uncomfortable!
Miss the deadline? Yikes — you're subjected to a 25% penalty on whatever you should have withdrawn. If you fix your mistake within two years, you get a break. The excise tax can be lowered to 10%. The penalty can be waived if you file Form 5329 and attach a letter of explanation.
Taxes
RMDs count as ordinary income, just like your regular paycheck. When we process RMDs for clients, we can withhold monthly to ensure you meet your tax liability or handle quarterly tax estimates through withholdings from your IRA. You can even wait until December to withhold the year's worth of taxes — no penalties! The benefit? Your money continues to grow in your account throughout the year; you get interest and appreciation instead of giving it to the government in advance.
Special Rules for Inherited IRAs
Have you inherited an IRA? The rules differ, especially for accounts inherited after December 31, 2019. Most non-spouse beneficiaries need to empty the account within 10 years. Spouses get more flexibility — they can treat it as their own or keep it as an inherited IRA. There are some notable exceptions for minor children and other beneficiaries, too. If you inherit an IRA, get advice from a financial planner on liquidating the account effectively and efficiently. There are A LOT of planning opportunities with inherited accounts, but each opportunity is unique to the person's situation.
This flow chart is a quick visual regarding the rules of inherited IRAs:
Getting Ahead of the RMD Game with Roth Conversions
You can make some really clever moves before those RMDs kick in, and one of my favorites is the Roth conversion. Think of it as a financial chess move — you're thinking several steps ahead.
Instead of waiting for RMDs to force your hand at 73 (or 75), you can start converting portions of your traditional IRA to a Roth IRA years before. Why would you do this? Well, imagine being able to control your tax situation instead of having the IRS dictate it through RMDs!
Who's a Good Candidate for Roth Conversions?
- Currently in a lower tax bracket than you expect to be in RMD age
- Have a few years before Social Security kicks in (this can be your perfect "conversion window")
- Have cash available outside your IRA to pay the conversion taxes
- Looking to reduce future RMDs
- Want to leave tax-free inheritance to your kids or grandkids
The sweet spot for Roth conversions is often between retirement and when RMDs begin. Your income might be lower during these years, making it the perfect time to pay taxes on conversions at a potentially lower rate.
Roth conversions have numerous long-term positive impacts. Every dollar you convert to a Roth is one less dollar subject to future RMDs. Plus, once that money's in a Roth:
• It grows tax-free forever
• You never have to take RMDs from it during your lifetime
• Your beneficiaries can inherit it tax-free
• It won't impact (if done well) your Medicare premiums or Social Security taxation down the road
Other Smart Strategies
Beyond Roth conversions, here are some other clever moves to consider:
Qualified Charitable Distributions (QCDs)
Once you hit 70½, you can donate up to $100,000 annually directly from your IRA to charity. This counts toward your RMD but doesn't increase your taxable income. It's like getting a tax deduction without even itemizing!
Strategic Account Consolidation
Having multiple retirement accounts is like conducting an orchestra with too many instruments. Consolidating them can simplify your RMD calculations and help you track your withdrawals better. Plus, it makes it easier to implement a cohesive investment strategy. Consider consolidating all your pre-tax retirement accounts into an IRA. In an IRA, you have increased flexibility and control over your tax withholdings and can implement a QCD strategy. If you after Roth retirement accounts, I consider consolidating your Roth accounts to a Roth IRA so you can avoid RMDs with those assets.
Early Withdrawals Strategy
Starting withdrawals before you're required can be smart. This can help you spread your tax liability over more years, take advantage of lower tax brackets, reduce the size of future RMDs, and create flexibility in your retirement income planning.
Ready to Take Control of Your RMDs?
Don't let all these rules and numbers swim around in your head! We're here to help you navigate the RMD waters and find some tax-saving opportunities along the way. Let's chat about strategies that could work for you — whether it's Qualified Charitable Distributions, Roth conversions, or other smart moves to keep Uncle Sam happy while maximizing your retirement savings.
Give us a call or schedule an appointment today. We promise to make RMDs less intimidating (and maybe even a bit interesting)! After all, it's your money — let's make sure it works as hard for you in retirement as you did earning it.
~ Rachel Bubb