Copy of 3 Things to Know About RMDs

3 Things to Know About Required Minimum Distributions and How to Reduce Them

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Required Minimum Distributions (RMDs) are like the flies that the government sprinkles into your retirement punchbowl. If not handled properly, many retirees suddenly find themselves paying significantly higher taxes in retirement than they did in their working years. These mandatory withdrawals from your IRA or 401(k) are crucial to strategically plan for in any retirement plan. Understanding the details of RMDs can help you make more informed financial decisions. Below are three essential things to know about RMDs, along with a couple of strategies to help avoid paying excessive taxes on these distributions.

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1. When You Must Start Taking RMDs and How Much

RMDs are a way for the government to reclaim the “tax benefit” they gave you during your working years. Most Americans contribute to their 401(k) or IRA throughout their working years receiving a tax deduction for those contributions. The government then requires those contributions and subsequent investment growth be withdrawn from the account starting at age 73 for those born after 1950. In recent years, the government has increased the starting age for RMDs. Why is this smart? They are allowing the assets for retirees to grow to a greater level, requiring more substantial funds to come out in later years, which ultimately leads to more tax dollars.

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Key Example:

• The amount of your RMD is calculated based on a life expectancy factor and your account balance. Sally turns 73 years old in 2024 and has $1,000,000 in her traditional IRA at the beginning of the year. Her RMD will be calculated by taking $1,000,000 divided by the life expectancy factor of 26.5. In 2024, Sally will be required to withdraw $37,736.

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Strategy: Diversify Your Savings into Taxable and Roth Accounts

One way to manage the tax impact of RMDs is by diversifying your savings across Roth accounts and taxable accounts (non-retirement brokerage accounts) during your working years. By doing so, you can strategically withdraw funds in your early years of retirement and plan ahead for RMDs in the future.

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Why It Works:

• These additional account buckets allow you to control your taxable income in the early years of retirement before RMDs and can provide income without triggering significant tax. Utilizing these funds can provide opportunities for significant Roth conversion.
• Taxable investment accounts and Roth accounts are not subject to RMDs in your lifetime. The more funds that are in these buckets, the greater control you have over your tax picture in retirement.

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2. RMDs Are Taxable as Ordinary Income

Every dollar that comes from a traditional IRA or 401(k) including RMDs are generally treated as ordinary income, and they are subject to federal (and sometimes state) income tax. Many people do not realize that this additional income can also bump up the amount their social security is being taxed and potentially increase your Medicare premiums.

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Key Example:

• Sally had been living off of Social Security, some investments she had in a non-retirement account, and her pension. Her total AGI before RMDs was $50,000 a year. Before RMDs, she owed $0 in taxes. After RMDs, she will pay additional tax on social security, totaling $9,200 in total tax, or 24% on every dollar from that RMD.

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Strategy: Qualified Charitable Distribution (QCD)

Once you are at the Required Minimum Distribution age, it becomes more difficult to tax manage the distributions. However, if you are charitably minded, you can utilize a Qualified Charitable Distribution (QCD) to reduce the amount of taxes you pay on your RMDs. QCDs allow you to donate up to $100,000 annually directly from your IRA to a qualified charity. The QCD amount counts toward your RMD, but it is excluded from your taxable income.

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Why It Works:

• The amount of the QCD is not included in your adjusted gross income (AGI), which helps reduce your taxable income and avoids bumping you or your social security into a higher tax bracket.
• It also allows you to get a tax benefit for your charitable giving when most retirees no longer itemize and just use the standard deduction.

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3. Your Heirs May Have to Take Distributions from Inherited Accounts

If your heirs inherit a traditional IRA or 401(k), they may be required to take distributions, even if they haven’t reached retirement age. Under the SECURE Act, most non-spouse beneficiaries must completely empty inherited accounts within 10 years of the original owner's death. This rule applies to both traditional and Roth IRAs, but there's a key difference: distributions from traditional accounts are taxed as ordinary income, while withdrawals from inherited Roth IRAs are tax-free.

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Key Example:

• Sally passes away in 2025 and leaves her $1,000,000 IRA to her son Jason. Jason now has to take out more than $100,000 a year in order to completely deplete that account over 10 years. Being an engineer and in his peak earning years, Jason will pay 32% taxes on every dollar that comes out of the inherited IRA.

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Strategy: Roth Conversion

Roth conversions are not only helpful to reduce RMDs of the original account owner, but they also provide a tremendous benefit to the heirs of these accounts. Instead of paying 32% tax on distributions from the Traditional IRA, Jason would be able to withdraw money from an inherited Roth IRA tax free.

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Why It Works:

• Although inherited Roths still have to be withdrawn within 10 years, they can be withdrawn completely tax free.
• Converting to Roth in the earlier years of retirement before RMDs also allows those assets to grow tax free during your lifetime and can provide a significantly increased amount of tax adjusted inheritance.

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Conclusion

Understanding the rules around RMDs and using smart strategies like diversifying your savings, utilizing QCDs, and looking at Roth Conversion annually can help you reduce the tax burden of required withdrawals in retirement. By managing your distributions proactively, you can preserve more of your retirement savings, keep your tax bill in check, and provide a greater benefit for your heirs. If you are interested in any of these strategies, feel free to schedule a meeting to discuss HERE or check out our educational videos on Roth Conversion HERE.

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~ Logan Gilland, CFP?

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Disclosures

Joule Financial, LLC is registered as an investment adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability. A copy of Joule’s current written disclosure brochure filed with the SEC which discusses among other things, Joule’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov

The content in this educational piece is for informational purposes only and should not be considered as personalized investment advice. Please consult a qualified financial advisor before making any financial decisions.

This does not constitute an offer or solicitation. This information should not be considered investment advice.

The information provided is accurate as of this publication and may change due to tax law updates or regulatory changes.

All investments carry risk, and the value of your investments may increase or decrease. RMD calculations and strategies should be reviewed with a qualified financial professional. For personalized tax advice, consult a qualified tax professional. The IRS rules and requirements on RMDs can change, and individual circumstances may affect outcomes.