Retirement Plan Required Minimum Distributions: Planning tips

In part 1 of this two-part article, we provided a review and summary of the evolving and potentially complicated rules regarding Required Minimum Distributions (RMDs).

In part 2, we examine possible planning suggestions for RMDs.

Planning for RMDs

For individuals fortunate enough to own retirement accounts, encountering the RMD rules will likely be inevitable. However, there are some opportunities to possibly delay or minimize the impact of RMDs.

Keep Working

As indicated above, one of the main reasons for RMDs is to ensure that the government eventually receives tax revenue on the money that was contributed pre-tax and grew tax deferred. However, savers in a 401(k) who continue working past 73 and don’t own 5% or more of the company, can delay distributions from the 401(k) at their current workplace until they retire.

This exemption only applies to your 401(k) at the company where you currently
work. If you have an IRA or a 401(k) from a previous employer, you will have to follow the RMD rule. 

Convert to a Roth IRA

Another strategy for some retirement savers looking to avoid drawing down required distributions is to convert some of their retirement accounts into a Roth IRA. Unlike a traditional IRA or Roth 401(k), which require RMDs, a Roth IRA doesn’t require any distributions at all. That means the money can stay—and grow tax-free—in the Roth IRA for as long as you want, or it can be left to your heirs.

Contributing to a Roth IRA won’t lower your taxable income, but you don’t have to pay taxes on withdrawals from earnings if you are over 59½ and you have had the account open for five years or more. Investors who have a mix of money in a Roth IRA and traditional retirement savings accounts can manage their taxes more effectively.

Be aware, though, that moving pre-tax money from a retirement account into a Roth IRA means you must pay taxes all at once on those funds. Roth conversions can be expensive, whether you’re moving money from a 401(k) or a traditional IRA.

Limit Distributions in the First Year

A major complaint regarding RMDs is the taxes retirement plan owners must pay because of drawing down some of their retirement savings. This can potentially push a retiree into a higher federal income tax bracket when RMDs start. As previously discussed, retirees who turn 73 (75 starting in 2033) have until April 1 of the calendar year after they reach that age to take their first distribution. After that, they must take it by December 31 on an annual basis.

Many retirees opt to hold off on taking their first RMD because they figure they will be in a lower tax bracket when they retire. While holding off makes sense for many, it also means you will have to take two distributions in one year, which results in more taxable income and possibly a higher federal income tax bracket for the first year of distributions.

One viable option is to take your first distribution as soon as you turn 73 (unless you expect to end up in a significantly lower tax bracket) to prevent having to draw down twice in the first year.

Donate Distributions to a qualified charity by making a Qualified Charitable Distribution (QCD)

IRA plan owners with charitable intent that are subject to RMDs may want to consider making a Qualified Charitable Distribution (“QCD”) to a qualified charity. Under this technique the IRA owner makes a distribution from their IRA directly to the charity and the distribution qualifies as an RMD but is not a taxable distribution. Unfortunately, this technique only applies to IRAs and does not apply to a 401(k).

Beginning in 2024, the $100,000 cap on a QCD is indexed for inflation.  If the contribution for 2024 is $105,000 or less—and is rolled out of the IRA and directly to the charity—you won’t have to pay taxes on the RMD. 

To get the tax break, the charity must be deemed qualified by the IRS. However, under SECURE Act 2.0, IRA owners can do a one-time QCD of up to $53,000 through a charitable gift annuity, a charitable remainder unitrust or a charitable remainder annuity trust.

You must be at least 70½ on the date of the QCD. For example, if you turn 70½ on November 1, you must wait until that day or later to make the transfer. Also, please be aware of a complex rule if you have made deductible IRA contributions after age 70½. Essentially, those IRA contributions reduce the amount of your IRA eligible for tax-free QCD treatment. In this situation, transfers to charities as QCD would be taxable up to the amount of the post age 70½ IRA contributions.

Finally, note that the QCD is not deductible as a charitable deduction (since the RMD is not taxable). For many taxpayers, this is especially beneficial since due to current higher standard deduction amounts it is likely that regular charitable contributions may not have a current tax benefit. You may even feel you can give a bit more if you do it this way.

Final Thoughts

This summary provides an overview of RMD rules and planning possibilities.

Please contact your Herbein tax consultant if you have questions or need assistance with your RMD decisions.

While understanding required minimum distributions is crucial, retirement planning is a multifaceted endeavor.  Just like a successful team requires different players working together, a comprehensive retirement approach can benefit from collaborating with a coordinated team. Your advisors, which can include tax, lawyers, estate planning, and wealth management specialists, can work together to optimize your retirement income, and help you achieve your long-term financial and legacy goals.

Herbein Financial Group can be an important player on your team. Click here to learn more about Herbein Financial Group and our services provided.

Article Contributed by Barry Groebel.