When the government enacted legislation that allowed individuals to fund a Traditional IRA with tax-deferred income, those legislators also wanted to ensure that the taxes would eventually be paid. The concept was to defer income taxes until the time the money may be needed for retirement.
To ensure that the deferred taxes would eventually be paid back during the saver’s lifetime, a Required Minimum Distribution (RMD) of the balance commences when the individual turns 70 ½. The first year’s RMD is approximately 4% of the total of all tax-deferred IRA balances. Following that, the RMD percentage increases each year during retirement. The penalty for not withdrawing the RMD can result in a substantial penalty of 50% of the shortfall.
Below are a few strategies to consider that could help to reduce the pain of an RMD:
Individuals who will continue to accumulate substantial income from pensions and other sources can consider withdrawing portions of their IRA soon after age 59 ½, but only to the extent that the withdrawals do not force a higher tax bracket.
Defer Social Security
In some cases, deferring Social Security until 70 while using your IRA if needed up to that time can yield dual benefits. The RMD reduces while maximizing the Social Security benefits that increase each year that starting payments are deferred.
Conversion to Roth IRA
Converting portions of your existing traditional IRA into Roth IRAs before age 70.5 will allow the balance to continue to grow tax-free. Though taxes must be paid at the time of the conversion, subsequent withdrawals from the Roth IRA will be non-taxable.
Donating an amount equal to the RMD to qualified charities will offset the calculation of the taxable income.
Reinvesting into an Investment Account
One of the more popular strategies is to take the RMD, pay the taxes and reinvest the rest into a brokerage account. Investors can keep their money working for them.
Contact us if you’re interested in discussing any of these strategies.