How do I reduce Required Minimum Distributions (RMDs)?

If you have a substantial amount saved in traditional IRAs, 401(k)s, or other tax deferred retirement accounts, you may eventually face a question that catches many retirees off guard: How can I reduce required minimum distributions (RMDs)?

RMDs are required withdrawals from most traditional retirement accounts once you reach the applicable starting age. For most people today, that means beginning at age 73. The amount is generally based on your retirement account balance at the end of the previous year and an IRS life expectancy factor.

While you cannot simply choose a smaller RMD than the IRS requires, there are strategies you can use years in advance to potentially reduce future RMDs and the taxes they may create.

Why Would You Want to Reduce RMDs?

An RMD is more than just money coming out of a retirement account. For many retirees, it can increase taxable income at a time when they may not actually need the additional cash.

Traditional IRA and retirement plan withdrawals are generally included in taxable income. A larger RMD could potentially affect several areas of your retirement finances, including:

• Your federal income tax bill
• Your marginal tax bracket
• How much of your Social Security benefits are taxable
• Medicare related income adjustments
• The amount you have available to leave to heirs
• Your overall tax burden throughout retirement

The important thing to remember is that RMD planning should not start when you turn 73. By that point, some of your options may be more limited.

The best opportunity to reduce future RMDs is often before RMDs begin.

How Are Required Minimum Distributions Calculated?

Understanding how RMDs are calculated helps explain how you may be able to reduce them.

Generally, your RMD is calculated using your account balance as of December 31 of the previous year divided by an IRS life expectancy factor.

For example, imagine you have $1 million in traditional retirement accounts when you approach your RMD years. Your future RMDs will be based in part on that account balance.

If the account continues growing and you have not strategically reduced the balance, your future RMDs may also become larger.

That is why RMD planning is really about managing the size and tax characteristics of your retirement accounts before the withdrawals become mandatory.

What Strategies Can Help Reduce RMDs?

Consider Roth conversions before RMDs begin

One of the most common strategies for reducing future RMDs is a Roth conversion.

A Roth conversion moves money from a traditional IRA or other eligible retirement account into a Roth IRA. The converted amount is generally taxable in the year of the conversion, but qualified Roth IRA owners do not have lifetime RMDs.

This can create an opportunity to voluntarily pay taxes on some retirement money today rather than potentially paying taxes on larger mandatory withdrawals later.

However, Roth conversions need to be carefully timed. Converting too much in one year could push you into a higher tax bracket or create other tax consequences.

That is why we believe Roth conversions should be viewed as part of a larger retirement tax strategy rather than a one time transaction. At Guerra Wealth Advisors, we can help you evaluate whether converting a portion of your retirement savings makes sense for your situation and how much you may want to convert each year.

Use your retirement savings before RMDs begin

Another strategy is simply planning how you will use your retirement accounts during the years before RMDs begin.

If you have other sources of income or assets, it may be tempting to leave your traditional IRA untouched for as long as possible. But doing so could allow the account to grow significantly, potentially creating larger RMDs later.

Depending on your circumstances, strategically withdrawing from traditional retirement accounts before RMDs are required may help reduce the balance that future RMDs are calculated from.

The key is not to withdraw money simply to reduce an account balance. Instead, withdrawals should be coordinated with your income needs, tax bracket, investment strategy and long term retirement plan.

Saving money for retirement plan. Retirement Conceptual

Consider Qualified Charitable Distributions

If you are charitably inclined, a Qualified Charitable Distribution, or QCD, may be another valuable RMD planning strategy.

A QCD allows an eligible IRA owner who is at least age 70½ to make a distribution directly from an IRA to a qualifying charity. When the requirements are met, the distribution can generally be excluded from taxable income and can count toward your RMD.

This distinction is important.

A QCD generally does not reduce the RMD amount you are required to take. Instead, it can satisfy all or part of that RMD while potentially keeping that amount out of taxable income.

For someone who already gives to charity, this can be a particularly useful strategy.

For example, instead of taking your RMD personally and then donating money to charity, you may be able to direct an eligible distribution from your IRA straight to the charity.

The result can be a more tax efficient way to accomplish something you were already planning to do.

Look at Your Retirement Accounts as a Whole

Another mistake is looking at each retirement account separately instead of considering your entire retirement income picture.

Traditional IRAs, 401(k)s, Roth IRAs, brokerage accounts, Social Security and other sources of income can all interact with one another.

For IRA owners, the IRS generally allows the total RMD from multiple IRAs to be satisfied by taking the required amount from one or more of those IRAs. Employer retirement plans generally have different rules and may require RMDs to be taken separately from each plan.

That means account organization and withdrawal planning can matter.

Before RMDs begin, it may be worth reviewing:

• Which accounts are traditional versus Roth
• Which accounts have the largest balances
• Which accounts have different investment strategies
• Whether old employer retirement plans should be consolidated
• Which assets you expect to use for income
• Which assets you want to preserve for heirs

At Guerra Wealth Advisors, we look at these pieces together because reducing RMDs is not just about lowering one number. It is about coordinating your retirement income, taxes and investments.

If You Are Still Working, Know the Rules

If you are still working after reaching RMD age, your employer sponsored retirement plan may allow you to delay RMDs until you retire, provided the plan permits it and you are not a 5% owner of the business sponsoring the plan. Traditional IRAs generally do not receive the same exception.

This can create another planning opportunity for people who continue working later in life.

However, the rules can differ depending on the type of account and the specific plan. It is important to understand exactly when your RMD obligation begins rather than assuming that continuing to work automatically delays every RMD.

What If You Are Already Taking RMDs?

If you have already reached RMD age, your options are different.

You generally cannot simply decide to take less than the amount required by the IRS. Failing to take the required amount can result in an excise tax, although the penalty can be reduced when certain correction requirements are met.

Instead, your focus may shift toward making your required distributions as tax efficient as possible.

Depending on your circumstances, that could include:

• Using QCDs if charitable giving is part of your plan
• Coordinating RMDs with other retirement income
• Managing which assets you sell to fund spending
• Reviewing your tax bracket throughout the year
• Evaluating future Roth conversions when appropriate
• Planning ahead for the next year’s RMD

The goal is not necessarily to eliminate your RMD. The goal is to make the required distribution work as efficiently as possible within your overall retirement strategy.

The Best Time to Plan for RMDs Is Before You Need Them

RMDs are not something you have to wait until age 73 to think about.

In fact, the years leading up to RMD age can be some of the most valuable years for tax planning. Roth conversions, strategic withdrawals, charitable giving and thoughtful account management may all play a role in determining how much you eventually have to withdraw.

And reducing RMDs is only one piece of the bigger picture.

The right strategy depends on your retirement income, account balances, tax situation, charitable goals, investment strategy and plans for your money later in life.

At Guerra Wealth Advisors, we can help you periodically review these moving pieces and make adjustments as your retirement evolves. A strategy that makes sense at age 60 may look very different at age 67 or 72.

The important thing is to start planning before your RMDs are already locked into the equation. Get started with a free introductory session with a Wealth Advisor by clicking here.