I Have to Do WHAT With My IRA?
“Kent, is there any way we can get around these darn RMDs?”
This is a question I often get from clients as they approach the magic age of 70½, when the IRS will force them to begin taking taxable required minimum distributions (RMDs) from their IRAs. Although IRAs are a great retirement savings tool (they offer a tax deduction for contributions, as well as tax-deferred growth), there is a day of reckoning. Yes, the tax man cometh, and a portion of your IRA has been “owned” by the IRS since your very first contribution.
Generally, you must take your RMD by Dec. 31 every year. But you may delay your first RMD until April 1 of the year following the one in which you turn 70½. However, you then must also take a second RMD in that same year by Dec. 31.
From my experience, the RMD question is something that retirement savers often think about, sometimes years in advance. Although RMDs cannot be avoided (and in any case, good for you if you’re in a position to delay withdrawing from your retirement account until 70½, and only the annual minimum thereafter), here are three ways to potentially mitigate the tax bite:
Qualified Charitable Distribution (QCD): Once you have reached 70½, you may transfer up to $100,000 per year directly from your IRA to a qualified charity. Not only is the amount transferred excluded from taxable income, it also satisfies the current year’s RMD. What’s more, lowering your taxable income may reduce some taxes tied to adjusted gross income (for example, taxable Social Security earnings). Bear in mind that this strategy only makes sense if you were planning to make, and have budgeted for, a charitable contribution in the first place.
Roth conversion: Gradually shifting traditional IRA dollars to Roth IRA dollars (and paying taxes on the converted amount, preferably with funds from taxable accounts, not the IRA) can be an exceptional way to reduce the tax bite come 70½.
Here’s a real-life example of how this can work: Linda retired from her career as a nurse having accumulated a large balance in her IRA account and entered a significantly lower tax bracket than she was in when she was employed. Between her retirement date and 70½, she employed a series of Roth conversions to ensure that she realized at least enough income to absorb all of the available tax deductions. As a result, her IRA balance was much lower when she finally reached 70½, resulting in a smaller annual RMD.
Delay, then double down: This strategy likely has limited use, but it can be powerful given the right conditions. As previously mentioned, you can delay taking your first RMD to April 1 of the year after you turn 70½. This generally isn’t a popular option, as you would then have to take two RMDs in the same year, doubling the tax hit.
However, if you are planning to make a charitable gift that could potentially offset the taxable income of both RMDs, then taking two RMDs in the same year can be a great tax planning strategy. If you don’t intend to donate that much to charity in a single calendar year, consider making a contribution to a donor-advised fund, where you would receive a current-year deduction for the entire contribution but could then dole out charitable grants from the donor-advised fund according to your own timeline. Again, keep in mind that making charitable contributions to offset IRA income only makes sense if you had planned to make those contributions in the first place.
Preparing for how to handle RMDs from your IRA isn’t a project you should leave until you reach 70½ or older, as there are some steps you could take well in advance to potentially lower your lifetime tax bill. Of course, as with all tax strategies, you should consult your tax advisor to determine if any of these planning ideas are appropriate for you.
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