A woman considering RMD distribution strategies to minimize her tax liability in retirement.
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Required minimum distributions (RMDs) are mandatory yearly withdrawals from tax-deferred retirement accounts once you reach a specific age. Failing to take them results in penalties, and taking them increases your taxable income. If you don’t need the income, this can lead to higher taxes. A financial advisor can help you create an effective RMD strategy to lower your tax liability and better manage your retirement savings. Here’s a roundup of five to get started.
Roth conversions involve moving funds from a tax-deferred retirement account, such as a traditional IRA or 401(k), into a Roth IRA, which is not subject to RMDs. By executing a full or partial conversion before RMDs begin, you can reduce the balance in your tax-deferred accounts, potentially decreasing the amount of future RMDs and minimizing the associated tax burden. Roth IRAs also grow tax-free, making them attractive for long-term growth and estate planning.
That said, it is necessary to pay taxes on the amount converted. Still, it is possible to end up ahead with this tactic.
As an example, imagine a 68-year-old investor who has $500,000 in their traditional IRA. They decide to convert $50,000 per year for five years into a Roth IRA. By doing this, the investor gradually reduces the balance of their traditional IRA, which would otherwise be used to calculate future RMDs. If they convert $50,000 each year and pay a 24% income tax rate, they’ll owe $12,000 in taxes annually for each conversion.
However, the converted amount grows tax-free in their Roth IRA, and by age 73, the investor has moved $250,000 out of their tax-deferred account. This helps reduce their RMDs when they start at 73, potentially lowering taxable income and giving more control over retirement withdrawals. Additionally, Roth IRAs can be passed on to beneficiaries without RMD requirements, making them a valuable tool for estate planning.
Withdrawing money from your tax-deferred accounts beginning at age 59 ½ can be an effective way to reduce or even eliminate future RMDs. By gradually drawing down these accounts earlier, you can reduce the balance that would otherwise be used to determine RMDs, thereby decreasing the tax burden when RMDs are mandated at age 73.
For example, consider an individual with $600,000 in a traditional IRA at age 59 ½. Instead of waiting until age 73, they choose to withdraw $25,000 annually. Taking these early distributions helps reduce the balance in the IRA by $325,000 when they turn 73, assuming modest growth. This reduction results in a significantly smaller RMD amount at the mandatory withdrawal age.
Additionally, since the individual starts earlier, their annual withdrawals might place him in a lower tax bracket when compared with taking larger RMDs later on.
Qualified charitable distributions (QCDs) allow individuals aged 70 ½ or older to donate up to $105,000 in 2024 ($108,000 in 2025) directly from their IRA to a qualified charity. These distributions count toward satisfying RMDs but are excluded from taxable income, providing another way to reduce or eliminate the tax liability associated with RMDs.
For example, if someone is 73 and needs to take a $15,000 RMD, they can make a QCD of $15,000 to their chosen charity. This satisfies their RMD requirement without increasing their taxable income, reducing their tax liability. QCDs must be made directly to a qualified charity and cannot be directed to donor-advised funds or private foundations.
A qualified longevity annuity contract (QLAC) is a type of deferred annuity funded with retirement account assets that allows you to delay a portion of your RMDs until age 85. By purchasing a QLAC, you can exclude up to 25% of your IRA or 401(k) balance (capped at $200,000 in 2024 and $210,000 in 2025) from the calculation of RMDs.
For example, if you have $800,000 in their traditional IRA, you could allocate $200,000 into a QLAC in 2024. This reduces the amount used to calculate your RMDs and lowers your taxable income. The deferred payments from the QLAC begin at age 85, providing additional income later in retirement while offering more control over taxable distributions in earlier years.
Continuing to work past the age when RMDs typically begin can provide an opportunity to delay RMDs from your current employer’s retirement plan. If you are still employed at age 73 or older and do not own more than 5% of the company, you may be able to defer RMDs from your employer-sponsored 401(k) plan. You should note, however, that this does not apply to IRAs, which still require you to take RMDs even if you are working, and it also may not apply to 401(k) plans from a previous employer.
Still, for those for whom it’s applicable, this allows you to keep your 401(k) retirement savings growing tax-deferred while minimizing taxable withdrawals. For example, if a person is 73 and still working full-time, they can delay taking RMDs from their employer’s 401(k) plan. By doing so, they avoid adding RMDs to their taxable income for the year and allow their retirement savings to continue compounding. Additionally, they can keep contributing to their 401(k), further growing their retirement assets.
A woman reviewing her retirement plan to make adjustments for her goals.
Effectively managing your RMDs can significantly impact your retirement plan by reducing your tax liability and giving you more control over your savings. Strategies such as Roth conversions, regular withdrawals, QCDs, QLACs, or continuing to work allow you to customize your approach to meet your financial goals and create a more tax-efficient retirement.
A financial advisor can help you develop a withdrawal strategy to minimize the tax impact of your RMDs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know how much your nest egg could grow over time, SmartAsset’s retirement calculator could help you get an estimate.
Kara Miles is a news writer, who loves to write about politics, health, business, parenting, and finance. She has two kids, who she loves to take on adventures with her. She also loves writing about her hobbies as well.
