If you have money in tax-advantaged retirement accounts, you will be required to start taking required minimum distributions (RMDs) after your 73rd birthday.
That means you must start withdrawing a minimum amount of money from your accounts on a schedule determined by the IRS.
When you withdraw the money from these accounts, you will have to pay taxes on those distributions at your ordinary income tax rate. This can sometimes lead to a big tax bill.
However, there are ways you can avoid wasting money on these taxes. Here are six possible options.
Find Out: 8 must-do things before 60 for a stress-free retirement
First, what is an RMD?
When you have a tax-advantaged retirement plan, such as a 401(k) or IRA, the IRS wants to ensure you eventually withdraw money from the account so it can collect taxes.
To ensure the government gets its piece of your earnings, required minimum distributions start at age 73 for the following types of accounts:
- Traditional IRAs
- SIMPLE IRAs
- SEP IRAs
- 403(b) plans
- 401(k) plans
- 457(b) plans
- Profit-sharing plans
- Other defined contribution plans
If you do not take your RMDs when required, you will have to pay a 50% penalty on the money you were required to withdraw from your account. But if you do take them, you'll be taxed at your ordinary rate on the money.
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1. Roll funds over into a Roth IRA
With traditional IRAs, you can typically deduct your contributions from your income taxes. With Roth IRAs , you contribute after-tax funds, so you don’t have to worry about taxes later.
Because RMDs are not required from a Roth IRA, you may be able to avoid having to take these minimum distributions if you move your retirement money from a traditional IRA, 401(k), or another tax-advantaged account.
You can do this with a Roth IRA conversion, which occurs when you roll your money from your traditional account into a Roth.
However, rolling over your money into a Roth is a taxable event. You will owe taxes on any pre-tax funds you convert.
2. Keep working
If you have a 401(k), 403(b), or other small business retirement plan, you do not have to take RMDs starting at age 73 if you're still working and don’t own more than 5% of the business.
In these situations, you could wait to take RMDs until April 1 in the calendar year after you retire.
However, this works only for your current employer’s plan. If you have a traditional IRA or a 401(k) from a company you no longer work for, you will still need to take your RMDs at 73.
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3. Consider a QLAC
If you don't need the funds from RMDs starting at 73, you can use some of the money in your 401(k) or IRA to purchase a qualified longevity annuity contract or QLAC.
You are limited to contributing a maximum of $135,000 to a QLAC, and you cannot contribute more than 25% of any particular retirement account to fund your QLAC.
When you fund a QLAC, you can choose to start receiving income from it at a designated start date, which could be as late as 85. Any of the money you have invested in your QLAC will no longer count when RMDs are calculated. This means you don’t have to withdraw as much, which lowers your tax bill.
4. Marry someone younger
Oddly, the age of your spouse can affect the amount of required minimum distributions you are mandated to take. The IRS allows you to use different life expectancy tables depending on your unique situation.
The amount of your RMD is based on the balance of your accounts at the end of the previous year and a life expectancy factor based on your and your spouse's ages.
If your spouse is more than 10 years younger and is the sole beneficiary of your IRA, you'll use the Joint Life and Last Survivor Expectancy Table.
5. Donate money to charity
If you don't need the money to supplement your retirement income, you can donate all or part of your required minimum distributions directly to a charitable organization through a qualified charitable distribution.
The IRA will send the money directly from your account to the qualified charity of your choosing. You can then exclude the charitable contribution amount from your taxable income.
You must be at least 70 1/2 to begin making QCDs, and you can make a maximum of $100,000 in qualified charitable distributions annually.
You also must take the QCD by the deadline for the year's required minimum distribution (for most, the deadline is Dec. 31).
Make Money: 8 things to do if you're barely scraping by financially 6. Time your first distributions right
Rather than the year you retire, you can wait until April 1 of the calendar year after you turn 73 to take your first RMD. Some retirees wait to take their RMD because they think they’ll be in a lower tax bracket that year.
If you wait and take your first distribution the year after you turn 73, you’ll have to take another RMD by Dec. 31 of that year. Taking two RMDs could mean a larger-than-expected tax bill for that year.
Depending on your situation, it might be better to take your first RMD the calendar year you turn 73. A tax or financial advisor can help you decide the best timing for taking your RMDs.
Bottom line
If you’re planning for retirement, RMDs can complicate things. You may not want to take money out of your retirement accounts on a set schedule determined by the IRS.
But you must comply with RMD rules to avoid penalties, and you must be ready to pay taxes on the distributed funds, especially if you're trying to grow your wealth .
Tax advisors and software can help you understand your tax obligations and ensure you're paying the least amount of income tax possible.
Money tips that can work for everyone
No matter what your bank account balance is, there's always an opportunity to optimize and improve your finances. Here's a quick checklist of things you can look at today.
Focus on paying off your debt . Debt can hold you back from making progress with your overall financial well-being. Aside from cutting expenses, there are tools that can help you pay off debt faster like balance transfer credit cards and debt counseling.
Earning extra income can give you breathing room. If finances are tight, earning some extra money to supplement your income can make a huge difference. A new job is one option to consider, but if you're not ready to make a big change or already retired, a part-time side job could be a better choice.
Cut your expenses. It sounds painful and so not fun, but it doesn't have to be. Take a look at your biggest expenses because that's where you'll probably find the biggest savings. For example, auto insurance rates have been soaring so shopping around for a new insurance company can be the fastest way to cut your bill. Also, look for ways to cut your grocery bill (despite rising inflation).
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