As you approach retirement, Required Minimum Distributions (RMDs) become an essential part of managing your finances. These mandatory withdrawals from your retirement accounts can impact your tax bill, but with strategic planning, you can minimize the effect. Just because you’re done saving for retirement doesn’t mean you should stop thinking strategically. In fact, how you handle your RMDs could significantly influence your financial well-being during retirement.
Here are four smart strategies to consider when planning your RMDs to minimize taxes and maximize your financial flexibility.
What is a Required Minimum Distribution (RMD)?
An RMD is the minimum amount of money you must withdraw from certain retirement accounts, such as a traditional IRA, rollover IRA, or 401(k), once you turn 73 years old. (This threshold will increase to 75 in 2033.) The required amount is calculated based on your account’s value and your age, with the percentage increasing as you get older.
For example, at age 73, you are required to withdraw nearly 4% of your account’s value, while at 83, this percentage jumps to nearly 6%. Since most contributions to IRAs were tax-deferred, these withdrawals are typically treated as taxable income.
Now that you know the basics, let’s explore how to manage these distributions to your advantage.
1. Start Withdrawing at Age 59½
While you’re required to begin taking RMDs at age 73, you can start withdrawing funds as early as age 59½ without penalties. Although many people avoid doing this to keep their retirement savings growing, there is a strategic benefit to early withdrawals.
By reducing the balance in your retirement accounts before RMDs are required, you can lower future distributions, reducing your taxable income during retirement. If you anticipate higher taxable income in the future—such as from Social Security or other investments—this strategy could help you stay within a lower tax bracket.
Important: Only withdraw early if you’re disciplined and reinvest the money elsewhere, ideally in investments that continue to grow.
2. Take In-Kind Distributions
An often-overlooked strategy is to take in-kind distributions from your IRA, rather than cashing out. This means you transfer assets, like stocks or bonds, from your retirement account into a regular brokerage account without selling them.
You’ll still owe taxes on the fair market value of the assets at the time of transfer, but it allows you to keep your investments intact and continue growing. This approach also gives you more control over when and how much tax you’ll owe, as you can time the transfer to your advantage.
3. Move Your Account to Your Employer’s Plan
If you’re still working past age 73 and contributing to a 401(k) through your employer, you may be able to avoid RMDs by transferring your IRA balance into your employer’s retirement plan. As long as you’re actively contributing to your employer-sponsored 401(k), RMD rules don’t apply to these funds, offering a way to postpone distributions.
This strategy isn’t available in all situations, and there are a few downsides, such as fewer investment options in a 401(k) compared to an IRA. However, if delaying RMDs is your goal, this could be a worthwhile option to explore.
4. Convert to a Roth IRA
If you’d rather avoid the hassle of RMDs altogether, consider converting your traditional IRA to a Roth IRA. Roth IRAs are not subject to RMDs, meaning you can leave the funds in the account indefinitely.
However, the conversion itself is a taxable event. You’ll pay taxes on the amount you convert upfront, but the benefit is that any future gains within the Roth account are tax-free. This strategy is particularly advantageous if you convert when the market is down or when you’re in a lower tax bracket.
Additionally, you don’t have to use the converted funds to pay the taxes. You can pay out of pocket, allowing the full amount to continue growing tax-free in the Roth IRA.
By being strategic about how and when you take your RMDs, you can reduce your tax liability and potentially maximize the value of your retirement savings. Whether you start withdrawing early, take in-kind distributions, move your account to an employer-sponsored plan, or convert to a Roth IRA, each option has unique benefits that can enhance your financial stability in retirement.