Key Points:
- Applicable Accounts: Required Minimum Distributions (RMDs) apply to traditional tax-deferred retirement accounts like traditional IRAs and 401(k)s. Roth accounts, including Roth 401(k)s (due to the Secure 2.0 Act), are exempt.
- Changing Age Thresholds: The age to begin taking RMDs is currently 73. This is set to increase to age 75 starting in the year 2033.
- Strategies to Reduce RMDs: Tactics to lower your future RMDs vary by life stage and include diversifying into Roth accounts before retirement, performing Roth conversions in low-income years, and utilizing Qualified Charitable Distributions (QCDs) after age 70 and a half.
- Timing Your Withdrawal: You cannot lower your RMD amount by taking it when the market is down. The distribution is calculated based on your account balance at the end of the previous calendar year (December 31).
- The Silver Lining: RMDs can be used strategically to rebalance your portfolio by selling overweighted assets. If you don’t need the funds, they can be reinvested into a taxable brokerage account or a Roth IRA, subject to contribution rules.
Required Minimum Distributions, or RMDs, are a familiar, if often disliked, aspect of retirement planning. These mandatory withdrawals from tax-deferred retirement accounts come with a tax bill and a set of rules that can seem complex. In a recent discussion, Christine Benz, Morningstar’s director of personal finance and retirement planning, broke down the essential questions retirees have about managing their RMDs effectively.
Understanding the Basics of RMDs
Navigating the landscape of RMDs begins with understanding which accounts are affected and the key age milestones that trigger these mandatory withdrawals. The rules have evolved in recent years, making it crucial for retirees to stay informed.
Which Accounts Are Subject to RMDs?
According to Benz, the RMD rule applies to virtually any traditional tax-deferred account. This includes traditional IRAs, 401(k)s, 403(b)s, 457s, and SEP IRAs. Essentially, if you received a tax deduction on your contributions and your money grew tax-deferred, the IRS requires you to start taking distributions in retirement.
The notable exception is anything with a “Roth” label. Roth IRAs have always been exempt from RMDs for the original owner. A significant recent change resulting from the Secure 2.0 Act now also exempts Roth 401(k)s from RMDs, aligning them with the tax treatment of Roth IRAs.
The Ever-Changing RMD Age
The age at which retirees must begin taking RMDs has been a moving target. For many years, the age was 70 ½, which briefly moved to 72. “It’s now at 73,” Benz confirms, noting that this age will remain the standard until 2033. “And then in 2033, it’s set to move out to age 75.”
The Financial Impact and Strategies to Mitigate It
Many affluent retirees dislike RMDs because the withdrawals increase their taxable income, potentially pushing them into a higher tax bracket. This can also lead to other costly, knock-on effects.
Why High-Income Retirees Dislike RMDs
The primary issue with RMDs is the tax liability. However, a significant secondary concern for many is the income-related Medicare adjustment amount, or IRMAA. This is a surcharge on Medicare premiums for higher-income individuals. An RMD can increase a retiree’s income enough to trigger these higher premiums, creating an unwelcome financial surprise.
Proactive Strategies to Lower Your RMD Burden
Thankfully, retirees have several tools at their disposal to manage and potentially reduce their future RMDs. The best strategy, Benz advises, depends on your current life stage.
For Those Not Yet Retired:
The most effective long-term strategy is tax diversification. While continuing to contribute to traditional tax-deferred accounts, individuals can also fund Roth accounts and taxable brokerage accounts, neither of which are subject to RMDs.
For Those Retired but Not Yet Taking RMDs:
This period is often called the “sweet spot” for RMD planning because you have more control over your taxable income. During these years, you might consider accelerating withdrawals from traditional accounts or executing Roth conversions while your income is relatively low.
For Those Age 70 ½ and Older:
A powerful tool is the Qualified Charitable Distribution (QCD). This allows you to donate up to $100,000 annually directly from your traditional IRA to a qualified charity. The amount satisfies your RMD requirement but is not included in your adjusted gross income, providing a significant tax benefit.
For the small subset of individuals still working past age 73, RMDs from their current employer’s plan can be delayed until they officially retire.
Smart Maneuvers and Finding the Silver Lining
While some common ideas about gaming the system are myths, RMDs offer hidden opportunities for savvy retirees to improve their financial position.
The Myth of Timing the Market
A frequent question is whether one can lower an RMD by taking it after a market downturn. Benz clarifies that this is not possible. “Your RMD amount is based on whatever your balance was at the end of the previous year,” she explains. For example, your 2025 RMD is calculated using your account balance from December 31, 2024.
Finding the Silver Lining in Mandatory Withdrawals
Despite the tax implications, RMDs can be beneficial. Benz points out two key advantages:
- Portfolio Rebalancing: The IRS does not specify which assets you must sell to satisfy your RMD. This allows you to strategically sell from holdings that have become overweight in your portfolio, helping you to rebalance without incurring separate transaction costs.
- Reinvesting Unneeded Funds: If you find yourself with RMD funds that you don’t need for living expenses, there’s nothing stopping you from reinvesting the money. After paying the taxes, the cash can be moved into a taxable brokerage account or even contributed to a Roth IRA, provided you meet the eligibility requirements.
By understanding the rules and employing these strategies, retirees can turn a mandatory withdrawal into a strategic financial move.
Image Referance: https://www.morningstar.com/retirement/faqs-rmds-what-retirees-need-know
