Required minimum distributions (RMDs) force you to withdraw from certain savings accounts later in life.
Those mandatory withdrawals can create a huge tax headache.
You may be able to put off RMDs or even avoid them completely.
For many retirement savers, one of the most frustrating parts of having money in a traditional IRA or 401(k) is having to deal with required minimum distributions, or RMDs. RMDs begin at either age 73 or 75, depending on when you were born. And they have the potential to create a big tax headache.
The reason RMDs exist is simple. The IRS gives you a tax break on contributions to a traditional IRA or 401(k). It wants to be able to tax you on that money at some point, so you’re forced to take withdrawals.
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The IRS also doesn’t want IRAs and 401(k)s to become tools the wealthy use to pass money down from generation to generation without having to pay taxes. Imposing RMDs effectively forces retirees to withdraw much of their savings in their lifetime, making that wealth transfer more difficult.
But understanding why RMDs exist doesn’t necessarily make them something you’re thrilled about. And if you hate the idea of having to take them, here are a couple of things you can do about it.
You may be aware of your RMD age. But did you know that if you’re still working, you may not have to take your RMDs just yet?
Let’s say you’ve been with the same company for decades and have all of your retirement savings in a traditional 401(k). If you’re turning 73 this year, you’d normally have to start RMDs. But if you’re still working for that company and don’t own 5% of it or more, you’re exempt from taking RMDs as long as you’re still on the payroll.
Now do keep in mind that this exemption only applies to retirement accounts sponsored by the company that’s still employing you. If you have an old 401(k) from a previous employer or a separate IRA, RMDs will apply to those accounts. But in some cases, continuing to work could get you out of taking RMDs completely.
If you missed the boat on funding a Roth IRA, you may be kicking yourself now. Roth IRAs don’t force savers to take RMDs, and they offer the benefit of tax-free withdrawals to boot. But if not old enough to be liable for RMDs, you can try converting your traditional retirement account to a Roth in the hopes of avoiding them.
For example, say you’re 68, which means RMDs don’t have to begin for another five years. If you have a $500,000 balance in a traditional IRA, you could move $100,000 a year into a Roth by the time you’re 73.
Now you should know that Roth conversions do count as taxable income. For this reason, you need to plan for them carefully, especially if you’re enrolled in Medicare. That’s because pushing your income too high could cause you to pay more for Parts B and D. But otherwise, Roth conversions are a great way to minimize RMDs or, in some cases, potentially avoid them completely.
It’s natural to not be a fan of RMDs. But with the right knowledge and planning, you can prevent them from becoming too much of a problem.
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