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Required Minimum Distributions (RMDs) are mandatory annual withdrawals from deferred retirement accounts once you reach a certain age. Failure to take them will result in fines, and failure to take them will increase your taxable income. If you don’t need the income, it could lead to higher taxes. A financial advisor can help you develop an effective RMD strategy to reduce your tax liability and better manage your retirement savings. Here’s a look at five to get you started.
Roth Conversions involve moving money from a tax-deferred retirement account, such as a traditional IRA or 401(k)in a Roth IRA, which is not subject to RMDs. By making a full or partial conversion before the RMDs begin, you can reduce the balance in your tax-deferred accounts, potentially reducing the amount of future RMDs and minimizing the associated tax burden. Roth IRAs also grow tax-free, making them attractive for long-term growth and estate planning.
That said, it is necessary to pay tax on the converted amount. Still, it is possible to lead the way with this tactic.
For example, imagine a 68-year-old investor who has $500,000 in a traditional IRA. They decide to convert $50,000 a year into a Roth IRA for five years. By doing this, the investor gradually reduces the balance of their traditional IRA, which would otherwise be used to calculate future RMDs. If they convert $50,000 each year and pay a 24% income tax rate, they will owe $12,000 in taxes annually for each conversion.
However, the converted amount grows tax-free in their Roth IRA, and at age 73, the investor has withdrawn $250,000 from their tax-deferred account. This helps lower their RMDs when they start at age 73, potentially lowering taxable income and giving them more control over retirement withdrawals. Additional, Roth IRAs can be passed on to beneficiaries without RMD requirements, making them a valuable estate planning tool.
Withdraw money from your tax-deferred accounts starting at age 59 ½ can be an effective way to reduce or even eliminate future RMDs. By gradually withdrawing these accounts earlier, you can reduce the balance that would otherwise be used to determine RMDs, lowering the tax burden when RMDs are required at age 73.
For example, consider an individual with $600,000 in a traditional IRA at age 59.5. Instead of waiting until age 73, they choose to withdraw $25,000 annually. Using these early distributions will reduce the balance in the IRA by $325,000 when they turn 73, assuming modest growth. This reduction results in a significantly smaller RMD amount at the mandatory withdrawal age.