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Tips for RMD Season

Required minimum distributions, or RMDs, are the tax-deductible payouts that investors must take out of their traditional IRAs, 401(k) plans, 403(b)s, 457s, SIMPLE IRAs and SEP-IRAs after becoming 70½. Retired households often have to dip into their retirement accounts for monthly income needs and have no problem meeting the minimum requirements. However, people with other sources of income may be forced to withdraw from their IRAs simply because they have reached the age of mandatory distributions. For these people, the withdrawal just leads to 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. Conversion to a Roth IRA

Today the only retirement accounts not subject to required withdrawals are Roth IRAs. So it’s 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, however, so this is usually only a good option when you have a few years to plan before reaching age 70½ or are certain that these funds will not need to be used and will be carried over into the future. generations Also, be aware that President Obama proposed adding RMDs to Roth IRAs in his fiscal 2017 budget and while it did not happen, 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 reduces your required distribution and may even completely satisfy the requirement while 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 on total income taxes.

3. When to Withdraw

Since the government determines the amount of the RMD, choosing when to withdraw the payment is a matter of strategy. The first cash distribution required is by April 1 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 every year, so delaying until 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 throughout the year within the retirement account.

4. Late RMDs

While many people will stop working at 70 ½, more and more active and healthy people are enjoying working well past age 70. For those who continue to work even part-time, the RMD can be delayed. Many employer-based plans allow for deferral of distributions until after actual retirement, but this only applies if you work for that employer. This is a great way to defer additional income tax, so it’s important to research what options the employer plan offers. Note that you can take advantage of the deferral only if your retirement account is with your current employer. Outside IRAs or old rollover plans will still be subject to the RMD rules.

RMDs are mandatory upon reaching 70½. So it’s important to talk to 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 strong 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.

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