7 Ways to Limit Required Minimum Distributions
A Quick RMD Refresh
In case you’re a little fuzzy on RMD details, here’s a quick primer.
RMDs are a requirement that the IRS places the owners of tax-deferred retirement accounts to begin making withdrawals at a certain age.
The purpose is to force the realization of taxable income from the account which has up to that point been safely shielded from taxes.
So, when you reach RMD age you will be required to remove a percentage of the account’s assets and pay income taxes on the withdrawal.
We’re not going to dive into the details of calculating your RMD in this post, but you can look up the IRS Uniform Lifetime Table to learn more.
Fail to remove your RMD and you’ll owe a 25% penalty on the amount you were supposed to withdraw every year that you fail to remove the amount.
The IRS will reduce this to a 10% penalty if you correct your mistake before the end of the second year following the oversight.
The required age for RMDs has shifted quite a bit over the last few years. Here’s a summary so you can find your current RMD age:
- Before 2019, RMD age was 70.5
- In 2018, the age was moved back to 72
- Secure Act 2.0 moved RMD age to 73 in 2023 (if you turn 72 in 2023 or later), and
- Beginning in 2033 the age will move up to 75
Again, special thanks to the U.S. Congress and the IRS for making things so easy for us to follow. (/sarcasm)
In many cases, retirees find that they don’t actually need the income that RMDs produce and instead look for ways to reduce their withdrawals, and the associated taxes, altogether.
In this post, we’ll cover seven ways you can make that happen.
1) Keep Working
As long as you are working, you are not required to take RMDs from your employer-sponsored retirement plan at your current job.
Note, the emphasis on your current job.
If you have an old 401(k) or other employer-sponsored plan, it will not be exempt from RMDs when you reach the appropriate age.
IRAs are also not exempt from RMDs if you are working.
If you want to keep working to avoid RMDs and want to shelter your old employer-sponsored plans or IRAs from RMDs you could look into rolling them into your current employer plan.
While this would effectively delay RMDs for whatever assets you manage to move, remember that your calculated RMD as a percentage of your portfolio will increase with age.
This means the longer you delay full retirement, the higher your withdrawal amount and income tax will be.
However, if you’re one of the lucky people who enjoy your work, this is one strategy to consider.
2) Start Withdrawing at 59.5 (or 55)
Obviously, if you can reduce the overall amount of your retirement accounts, your RMDs will be smaller because they are taken as a percentage of the total assets in the accounts.
So, in the years leading up to RMD age, you could make distributions from the account in an effort to reduce the overall balance that will be subject to RMDs.
For most retirement accounts, you’ll need to wait until you are age 59.5 to begin making qualified withdrawals, though you can begin taking distributions from a 401(k) at age 55 if it is associated with the employer you retire from at age 55 or later.
3) Convert to a Roth IRA or Roth 401(k)
Option three is to convert your tax-deferred accounts to a Roth-type account.
This strategy produces the same balance-reducing effect as option #2, but it also has the added benefit of putting more of your money into a Roth account where it can continue to grow completely tax-free.
Any conversions from a Traditional to a Roth will be subject to income tax in the year in which they occur, so it pays to be strategic about this and plan these conversions in years when your income that is subject to taxes is low.
This ensures that the conversions are taxed at the lowest possible marginal tax rate, potentially saving you thousands in income taxes.
4) Invest Conservatively
Next, you can slow the growth of your tax-deferred accounts by making sure your more conservative investments are held there.
Specifically, I’m referring to assets like bonds that produce lower returns than stocks. Try to hold equity investments in Roth accounts first if you can.
Now I want to clarify that this strategy is secondary to your overall asset allocation goal. You do not want to alter your chosen asset allocation just to make sure you earn less in your tax-deferred accounts.
That would be penny-wise and pound-foolish.
For example, if your goal is to maintain a 60/40 stock-to-bond asset mix, you’d begin buying the bonds in your tax-deferred accounts until 40% of your portfolio was held in bonds.
If you reach 40% before you’ve allocated all the assets in your tax-deferred space, then start buying stocks (in mutual funds or ETFs of course) until all the assets are invested.
5) Make a Qualified Charitable Distribution
Qualified Charitable Distributions (QCDs) are a very handy way to reduce or eliminate your RMDs from an IRA completely.
Basically, a QCD is a distribution made to a charitable organization instead of the account owner.
You won’t get a tax deduction for the QCD since the assets in a tax-deferred IRA have never been subject to tax anyway.
However, your RMD amount for the year is reduced dollar-for-dollar by the amount of your QCD. This means you won’t be required to realize income in the amount of your QCD, reducing your tax liability for the year while also potentially keeping you in a lower tax bracket.
This is a very helpful planning tool for those who are charitably inclined, but there are some rules to follow.
First, you are limited to a $100,000 QCD per account owner in 2023 and $105,000 in 2024, though this amount increases with inflation.
You cannot make a QCD from a 401(k), but you can roll your 401(k) to an IRA and make a QCD there.
You must also make a QCD directly from your account custodian to your charity of choice.
If you make a distribution to yourself and then give the assets to charity, you will still have the option for deducting the gift, but your QCD has been blown up and you must still make an RMD.
Finally, even though RMD ages increased with the SECURE Act and SECURE 2.0, for some reason the eligible age for QCDs stayed at 70.5.
Thus, you can begin reducing your tax-deferred account balances before RMD age if you so desire*.
(*though, I confess, I can’t think of a financially advantageous reason to make QCDs before RMD age unless you expect your RMDs to one day exceed the annual allowable QCD amount. Frankly, this isn’t a problem that anyone should mind having.)
6) Purchase a Qualified Longevity Annuity Contract (QLAC)
A Qualified Longevity Annuity Contract (QLAC) is a deferred income annuity that is not subject to RMDs.
By purchasing one, you could effectively convert tax-deferred savings into an income stream, while also reducing the amount of your accounts that are subject to RMDs.
A QLAC provides income beginning at a specified age but there are no death benefits, meaning if you pass away before you begin collecting then the insurance company gets to keep everything.
It’s kind of risky, but the income streams are also typically much higher than other annuities.
Now, the maximum amount you can use to purchase a QLAC is $200,000 as of 2023** and you must begin taking distributions no later than age 85.
(**The rules for the maximum contribution have moved a lot in recent years, so be sure to check up on this.)
7) Plan Ahead
RMDs create a potential tax time bomb for disciplined savers.
In nearly every strategy we’ve provided advanced planning is either required or highly beneficial.
The good news is RMDs shouldn’t surprise you in retirement, so there’s time to mitigate your future tax liabilities if you start planning now.
I highly recommend forecasting the amount you expect to have in tax-deferred accounts before you turn 55 years old. There’s really no harm in doing it earlier if you want.
Typically, the first year RMD is around 4% of your tax-deferred balance.
If you believe that will exceed your income needs in retirement, pat yourself on the back, then start using the strategies we’ve listed above to reduce your tax liability down the road.
Many people begin using these tactics in the years following retirement but preceding Social Security and/or RMDs because they find they have a higher degree of control over their income tax situation during this period.
If you begin withdrawing from your retirement accounts at age 59.5 you could have up to 15 years to alter your tax trajectory, so don’t delay.
