Required minimum distributions, or RMDs, are the taxable payouts that investors must take out of their traditional IRAs, 401(k) plans, 403(b)s, 457s, Simple IRAs and SEP IRAs after turning 70½. Retired households oftentimes have to tap into their retirement accounts for monthly income needs and have no issue meeting the minimum requirements. However, people with other sources of income may be forced to withdraw from their IRAs simply because they reached the age of mandatory distributions. For these people, the withdrawal only leads to an additional income tax and cash to be reinvested elsewhere. This is the time of year to start planning ahead and check if you have made your required withdrawal or consider ways to minimize the need.
1. Converting to a Roth IRA
Today the only retirement accounts not subject to required withdrawals are Roth IRAs. So it is always worth exploring the option of converting qualified accounts to Roth accounts to avoid future RMDs. Converting an account to a Roth incurs an immediate income tax, though, so this is usually only a good choice when you have some years to plan ahead before reaching age 70½ or are confident these funds need not be used and will be passed on to future generations. Also, be aware President Obama proposed adding RMDs to Roth IRAs in his 2017 fiscal budget and although it hasn’t happened it makes it is clearly on the radar of our politicians.
2. Directing RMDs to Philanthropy
A great way for investors to meet their RMDs and avoid income tax is to direct the distributions to qualified charities. In December 2015, Congress made the Qualified Charitable Distribution (QDC) provision permanent allowing for distributions directly from retirement accounts to qualified charities up to $100,000. The value of the distributions reduce your required distribution and can even completely meet the requirement thereby avoiding any ordinary income taxes. The trade-off is that a charitable distribution from a qualified account does not additionally qualify for a charitable deduction to overall income taxes.
3. When to Withdraw
Since the government determines the amount of the RMD, choosing when to withdrawal the payment is all about strategy. The first cash distribution required is by April 1st of the year after reaching 70 1/2. Because of this, there is often some wiggle room to delay the first distribution. If this is an option, be careful, because after reaching 70 ½ a distribution is required yearly, so delaying to the following April usually leads to two required distributions in a single calendar tax year-essentially doubling your tax burden. If it is one of the following years, and the funds are not needed for monthly expenses, it makes the most sense to take the distribution at the end of the year, allowing tax-deferred funds to grow all year within the retirement account.
4. Delaying RMDs
While many people will have stopped working by 70 ½, more and more active and healthy people enjoy working well beyond age 70. For those who continue to work even part-time, the RMD may be delayed. Many employer based plans allow deferment of distributions until after actual retirement, but this only applies if you are working for that employer. This is a great way to defer extra income tax, so it’s important to research which options the employer plan offers. Note that you can only take advantage of the delay if your retirement account is at your current employer. Outside IRAs or old rollover plans still will be subject to the RMD rules.
RMDs are mandatory upon reaching 70½. So it’s important to speak with your advisor about the best options for your individual situation. Just because you may not require the money for your personal situation, there is a hefty penalty for not taking the distribution. Having a strategy in place ahead of time will help you manage your taxes and make the most of your retirement accounts.