The buoyant stock market has increased the amount of money Americans have in their retirement savings plans, which is certainly a welcome development for seniors who will need that money to live on.
But most of the more than $13 trillion in savings accumulate in tax-deferred plans, meaning retirees will eventually have to pay taxes on them. And depending on the size of the account, that tax bill could be significant.
The IRS requires owners of traditional IRAs and other tax-deferred accounts to make minimum annual withdrawals starting at age 72.
Required minimum distributions are taxed as income, so a large withdrawal could put you in a higher tax bracket. In addition, more of your Social Security benefits may be taxable, you may lose certain deductions and credits linked to your modified adjusted gross income, and you may pay higher premiums for Medicare Parts B and D.
But here are some ways to reduce the size of your required withdrawals and, consequently, your tax bill.
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Tap your IRA for charity: If you’re age 70½ or older, you can donate up to $100,000 a year from your IRAs to charity through a qualified charitable distribution, and after you turn 72, it will count toward your required minimum distribution.
A qualified charitable distribution is not deductible, but it will reduce your adjusted gross income, which in addition to lowering your federal and state tax bill may also reduce taxes on items linked to your AGI, such as Social Security benefits and Medicare premiums .
Make sure the donation is made directly from your IRA to the charity; otherwise, it will not be considered a qualified charitable distribution.
You can’t make a qualified charitable distribution to a donor-advised fund or private foundation, and the recipient must be a 501©(3) charity registered with the IRS, says Mari Adam, a certified financial planner in Boca Raton, Florida.
Convert to a Roth: When you convert money from a traditional IRA to a Roth, you must pay taxes on the amount you convert (although part of the conversion will not be taxable if you’ve made nondeductible contributions to your IRA).
After conversion, withdrawals are tax-free, as long as you’re age 59½ or older and have owned a Roth for at least five years.
Unlike traditional IRAs and other tax-deferred accounts, Roth accounts aren’t subject to required minimum distributions, so if you don’t need the money, you can let it continue to grow, with no obligation to the IRS.
You can keep the cost of a conversion low by converting during the period between the year you retire and the year you must take required minimum distributions.
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