Each year, retirees of a certain age will be required to meet a specific withdrawal amount across their tax-deferred accounts. Based on account value and current age, Required Minimum Distributions (RMDs) begin (for those who were not 72 by the end of 2022) the year in which the account owner turns 73.
Many retirees seek out ways to reduce their RMDs now and in the future with the goal of more money actively invested for a longer period of time and potentially reducing yearly tax bills. Below are a few common strategies:
Roth Conversions
Roth IRAs are individual retirement accounts where contributions are taxed upfront, allowing all future growth and withdrawals to be tax-free. Moving all or part of a tax-deferred account to a Roth, where RMDs are not required, is one method for reducing future RMDs and tax bills.
The conversion will be a taxable event in itself, as taxes are paid upfront on the converted amount, so it may be wise to consult a financial professional to determine the best time to make the switch.
Reinvesting RMDs
For those who do not need their RMDs to supplement their income, another option is to transfer yearly RMDs into non-retirement accounts that are invested similarly to existing retirement accounts. This allows you to stay invested, continue building your retirement funds, and maintain flexibility in investment choices outside of retirement account restrictions.
Reinvested RMDs are still subject to income tax and non-retirement accounts do not offer the same tax advantages as do retirement accounts.
Tax Rates
If you are actively working and adding funds to a pre-tax account like a 401(k), it may be beneficial to consider your tax bracket and begin contributing to a Roth account or converting an existing account into a Roth. This can be especially advantageous if you can do so without moving into a higher tax bracket.
Balancing contributions between pre-tax and post-tax accounts helps manage tax liability and Roth accounts offer potential for tax-free growth and withdrawals. Contributions to Roth accounts do reduce current take-home pay due to their upfront taxation of contributions.
Incremental conversions from tax-deferred accounts into Roth accounts can mitigate tax impact by maintaining a consistent tax rate year over year. Careful planning will be required to avoid unintended tax consequences. Once retired, amounts that equal the previous year’s income can be converted. This allows for a similar, pre-retirement, tax bill while living off savings.
These strategies can smooth out your tax liability and tax rate over the course of several years, especially during retirement.
Optimizing the usage of your RMDs can be done in a myriad of ways but requires careful planning and proper timing of conversions and withdrawals to optimize tax efficiency. An experienced financial professional can help look at the full picture of your retirement circumstances and offer recommendations and a plan for your RMDs.
To schedule a complimentary financial review with Moore’s Wealth Management, click here or call our office at 770-535-5000, where a staff member is awaiting your call Monday through Friday, 9AM to 5PM.
Sources:
[1] https://www.kiplinger.com/retirement/roth-iras-what-they-are-and-how-they-work
[2] https://www.kiplinger.com/retirement/roth-conversion-dont-overlook-these-issues
[3] https://www.kiplinger.com/retirement/how-to-optimize-rmds-in-retirement
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