By Brian Bowen, Integrity Financial Planning, Inc. Posted on CNNMoney.com
Each year, we receive numerous calls from seniors worried about taking Required Minimum Distributions (RMDs) from their tax-qualified retirement accounts. Not only are the rules confusing, but also the options available within those rules can impact their retirement. Luckily, advice abounds on ways to lessen taxes on RMDs. Below are some of the most popular suggestions, but remember, there isn’t one simple solution that addresses each unique situation.
Delay the pain.
Once you turn 70½, you can wait until the following April 1 to take your first distribution, and potentially move the income tax on the distribution into the next tax year. Sounds like a great plan, but there’s a catch. Subsequent distributions must be made by December 31 of each year. This could result in a one-two hit to your income in one tax year. Unless you have significant losses to offset the income, your tax rate could substantially rise. Figure out what you can afford, and do the math, or have a planner help you strategize.
It’s true that as long as you own less than 5% of the company you work for and continue to work for that company, you may be able to delay taking RMDs from that employer’s plan until you retire. However, you are still required to take RMDs from all other existing 401(k)s and IRAs. Know your current plan’s rules, and determine the balance of your other tax-advantaged accounts before you decide to continue working.
Convert a portion of your IRA to a Roth IRA.
Roth accounts provide a nice alternative to pre-tax savings, since these accounts hold after-tax money, and if terms and conditions are met, you don’t have to take RMDs. Be sure it makes sense for your situation before you do this. Taxes are still required to be paid as you convert, and you may move into a higher tax bracket. In addition, when you decide to make the conversion, you may already be in a higher tax bracket.
Take distributions from the worst-performing account.
Absolutely good advice! However, how do you measure account performance, and are you comparing apples to apples or apples to oranges? IRAs are subject to investment fees by the firm that administers your account. Some are particularly high in variable annuities and actively traded mutual funds. Make sure that you understand your true net return before launching into this strategy.
Use your RMD for a charitable donation tax deduction.
Sounds simple, right? Maybe. Consider donating your RMD dollars to charity, but weigh your options before you leap. Under the renewed Qualified Charitable Donation (QCD) rule, you can have all or part of your distribution made directly from your IRA to a qualified charity (up to $100,000 per taxpayer, per year), and the amount is simply excluded from income (donor-advised funds are ineligible). It’s important to consult a qualified tax professional regarding your unique situation before making this decision. For instance, ask them if your charitable contributions exceed your deductible limit and if you should you itemize deductions.
In addition to regulatory framework and current tax structures, you need to consider the potential loss of tax-deferred growth from retirement accounts, the effect on RMDs, and the impact on Social Security, Medicare, and estate planning. Navigating RMDs and making the most of them is not for the faint of heart. Guidance from a qualified professional who accounts for all the facets of your financial life will yield the best result and keep you out of hot water with the IRS.
Contact us so we can help you with reducing the tax burden when taking withdrawals in retirement.
Integrity Financial Planning, Inc., is an independent Registered Investment Advisor based in Roanoke, VA.