5 Ways to Reduce Your Required Minimum Distributions

Managing the tax impact of your Required Minimum Distributions (RMDs) is a critical aspect of your retirement plan. RMDs are mandatory withdrawals from retirement accounts that kick in once you reach a certain age, typically 73 (for those born in 1951 or later). These distributions can lead to significant tax liabilities. However, there are strategies to minimize their impact and make the most of your retirement savings.

1. Roth Conversions

Converting traditional retirement accounts, such as a Traditional IRA or 401(k), into Roth IRAs can be a powerful tool to reduce future RMDs. Roth IRAs are not subject to RMDs during your lifetime, allowing you to keep the funds growing tax-free. By gradually converting some of your traditional retirement savings into Roth accounts, you can strategically manage your taxable income in retirement.

Keep in mind that Roth conversions are taxable events, so it's essential to plan these conversions carefully to avoid pushing yourself into a higher tax bracket. Two of the biggest mistakes when it comes to Roth conversions are converting too much or not converting enough. Calculated Roth conversion ladders are a good middle ground.

2. Delaying Social Security

By delaying Social Security, you will likely take more from retirement accounts in the earlier years, which will reduce your RMDs since there will be a smaller balance to base the calculation on.

3. Qualified Charitable Distributions (QCDs)

Qualified Charitable Distributions (QCDs) allow you to donate directly to qualified charities from your IRA once you've reached the age of 70½ and meet specific IRS requirements. The amount donated counts toward your RMD for the year, effectively lowering your taxable income.

4. Asset Location

Consider a retiree who calculates that their optimal asset allocation is 75% stocks and 25% bonds. The traditional approach would be to set all accounts to be 75% stocks and 25% bonds. However, this may be a poor tax strategy. One strategy that could be considered is to have Roth IRAs more aggressive and Traditional IRAs more conservative, while the overall allocation remains at 75/25. Since more aggressive accounts are likely to grow more over time, the growth in the Roth IRAs will be tax-free and the lower growth in the Traditional IRAs will lead to smaller RMDs. While you shouldn’t minimize growth in order to lower RMDs, there is often a need for bonds in a retiree’s portfolio and the IRA could be the right account to place them in.

5. Plan for Tax Impact on Heirs

Once your IRAs are inherited by your family (non-spouse), they are likely subject to the 10-year rule, where distributions must be taken over 10 years. This can lead to a significantly higher tax burden than what you would have had since you could stretch the distributions over 20+ years. Because of this, it may make sense to take more than the RMD during your lifetime to reduce the RMD that your heirs will have to take. Often, this planning is considered during the later years of retirement, in a retiree’s 80s or 90s.

Effectively managing RMDs is a crucial aspect of retirement planning. By implementing these strategies, you can reduce your RMDs and maximize your retirement savings.

Happy Planning,

Alex

This blog post is not advice. Please read disclaimers.