Here’s my simple explanation of required minimum distributions (RMDs): At age 72, Uncle Sam knocks on your door and asks you to pay taxes on your tax-deferred investments. You have gone perhaps years without paying taxes on these accounts, and he is $30 billion in debt. In more technical terms, an RMD is when you take a specific percentage (based on the IRS life expectancy table) out of your tax-deferred investments (401(k)s, IRAs, etc.) and pay taxes on it.
The older you get, the more that percentage increases. Most retirees not only see that percentage increase, but also see their investments grow. This combination can cause you to take out much more in the future, which can cause problems when it comes to paying taxes. It could move you into a higher tax bracket, make Social Security more taxable, push you into a higher Medicare premium bracket, and make capital gains taxable or more taxable.
Now, what if you don’t want to take your RMD? can you pass it You don’t want to do this, as the penalty is a 50% tax. I know not everyone wants to get their RMD out, but this is something you don’t want to miss out on. Fortunately, there are a few ways to make RMDs a little less of a hassle.
Strategy 1: Roth Conversions
You could deal with this now by lowering your RMDs in the future. This could involve taking money from your investments tax-deferred before age 72 or using a Roth conversion strategy. A Roth conversion is when you take money from a tax-deferred investment and roll it into a Roth IRA.
You pay tax now on this strategy, but it can make a lot of sense while tax rates are low and before the investment has a chance to grow any further. When your money is in a Roth IRA, you don’t need to take out an RMD, allowing your money to grow tax-free. Plus, any money you take from this account will be tax-free and won’t count as income, as long as you’re age 59½ or older and have had an open Roth for at least five years.
Keep in mind that if you’re 72 or older and taking RMDs, you can still do a Roth conversion, but you must first take out your RMD before you can do a conversion. For example, if you need to withdraw $10,000 from your IRA, but want to do a Roth conversion of $5,000, you must first withdraw $10,000 (which cannot be converted). You would then convert $5,000 on top of that, meaning your total taxable withdrawal amount would be $15,000.
Strategy 2: Charitable Donations
For my charitable clients who do not need to live off their RMDs, we recommend that they donate their RMD or a portion of it to a charity tax-free. This strategy is tax free for you and the charity. It’s called Qualified Charitable Distribution (QCD). To make a QCD, send the money directly to the charity so it is not counted as income.
I remember one of my clients was giving $10,000 to his church each year and was in the 22% tax bracket. He would take about $12,200 out of his IRA each year and then give it to charity. It didn’t go directly to charity. By doing this, he only gave away about $10,000 after taxes. He came to me asking what I should do with his RMD since he didn’t need the full amount. What a perfect opportunity. I told him to do a QCD and give the money directly to her church. Doing so saved him about $2,200 that year! That’s the power of a QCD if you have a charitable mindset.
Don’t pay more than you need
So the next time Uncle Sam knocks on your door, you’ll be a little more educated and hopefully have a better plan to keep your hard-earned money instead of tipping Uncle Sam and paying more than what belongs to you. And don’t forget that a financial professional he trusts can be incredibly helpful in this situation.
Investment advisory services and insurance services are offered through Peak Retirement Planning, Inc., a registered investment advisor.
Founder, Maximum Retirement Planning
As the owner of Peak Retirement Planning, Joe Schmitz Jr. specializes in comprehensive retirement planning. Joe focuses on helping clients grow and preserve their wealth. Through tax efficiency strategies, Social Security optimization, and proactive health care planning, Joe helps clients feel confident in their financial future and the legacy they leave behind. Joe graduated with a Bachelor of Science in finance and financial planning from Mount Vernon Nazarene University.
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