By Lee Sherman
If you don’t need the immediate cash, Required Minimum Distributions (RMDs) can come as an unwelcome shock. Simply put Required Minimum Distributions (RMDs) are the amounts that US tax law requires you to withdraw annually from a tax-deferred retirement account (such as traditional IRAs and employer-sponsored retirement plans such as 401(k)s) after you’ve reached age 72 (70 ½ if you reach 70 ½ before January 1, 2020). If you don’t withdraw the correct amounts, you will pay stiff penalties. And keep in mind that these withdrawals are taxable. In fact, that’s kind of the point.
RMDs allow the government to collect taxes for both the original tax deferral and tax-deferred growth, while assuming that the investor will most likely be in a lower tax bracket when they retire (hence the age requirement).
The CARES act passed in the wake of the global pandemic temporarily waived required minimum distributions (RMDs) for all retirement plans for calendar year 2020, including the first RMD, which individuals may have delayed from 2019 but it expired at the end of 2020. Individuals that are required to take an RMD must begin their withdrawals either again, or for the first time, in 2021.
While there’s nothing you can do to avoid taking these distributions, there are some things you can do to reduce the amounts you must withdraw.
Minimize the RMDs
Your current tax bracket will determine how you approach RMDs. If you are already in a low-tax bracket, you can take the distributions before you reach age 72. Not only will this provide you with liquid assets now, it will also lower the value of your retirement accounts, reducing RMD amounts after age 72.
Your financial advisor may recommend that you convert all or part of your traditional IRA to a Roth IRA in order to reduce the amount of the traditional IRA that is subject to RMDs. Roth Conversions are complicated and should only be done with the help of your financial advisor. You may still need to pay income taxes on the amount you convert.
There is one way to put off RMDs but it may not have much appeal. And that’s to keep working past the age of 72. You may be able to contribute either all or some of your tax deferrals to the Roth IRA in your employers’s 401(k) plan. While the RMD rules apply to all employer sponsored retirement plans including profit-sharing, 401 (k) plans, 403(b) plans, and 457(b) plans. and the Roth IRA in the 401(k), they do not apply to the Roth IRA while you are still alive, leaving the RMDs and the tax burden that comes with them to your beneficiaries.
Calculating the exact amount of the RMD is complicated and best left to the administrator of your retirement plan. Your financial advisor can help to determine the best time to take these withdrawals, keeping in mind your income tax bracket, which retirement plans make sense for you, and how long you’ll be able or desire to continue working.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.