Saving steadily into a traditional retirement account is one of the more disciplined things a person can do over a working life. What surprises people is what happens at the other end of that account. Under current rules, once you reach the applicable RMD age, the IRS requires you to begin taking minimum distributions each year. Whether you need the money or not, those distributions are generally included in taxable income, which means they can reach further into your retirement picture than most people expect. Understanding how it works gives you room to plan around it rather than react to it.
What a Required Minimum Distribution Is
When you save in a retirement account such as a traditional IRA or 401(k), your contributions may be made on a pre-tax basis, depending on the account type and your circumstances, and the money grows tax-deferred for years. Eventually, the IRS wants its share, and those funds generally become taxable as you withdraw them.
Under current rules, RMDs begin at age 73 for those subject to the current age-73 rule, and will begin at age 75 for younger individuals under SECURE 2.0. That is your required minimum distribution. The amount is calculated using your prior year-end account balance and an applicable life-expectancy factor published by the IRS, and distributions are generally taxed as ordinary income. In that sense, the money you saved was never entirely yours.
Why an RMD Can Affect More Than Your Tax Bill
For some retirees, required minimum distributions may be larger than anticipated. Because the withdrawal counts as income, it can push a portion of your income into a higher tax bracket, increase the tax on your Social Security benefits, and even raise your Medicare premiums. An RMD may carry several tax and income-related implications that are important to consider, and those effects are far easier to manage when you can see them coming.
The Penalty for Missing a Required Minimum Distribution
If you miss a required minimum distribution entirely, the IRS can charge an excise tax on the amount that should have been taken out. This is not a deadline to guess on. Because these rules, ages, and penalties are set by the IRS and can change, confirm the current figures with your tax professional.
The Years Between Retirement and Age 73
The stretch between when you retire and when RMD’s begin can be a unique tax planning opportunity. Depending on your circumstances, this is a period when your tax bracket may be lower than it will be later in retirement.
How a Roth Conversion Works
One strategy that can take advantage of this window is a Roth conversion. You move money from a traditional account into a Roth account and recognize the taxable amount of the conversion as income in that year, while your rate is potentially lower. From that point on, the money can grow tax-free, and qualified distributions are tax-free. Under current tax law, Roth accounts are not subject to required minimum distributions during your lifetime.
When appropriate, a Roth conversion may help reduce the amount held in a traditional or rollover retirement account, and it could affect future RMD obligations. A conversion does not remove the tax. It changes when you pay it, which may help if your tax rate today is lower than it would be when you withdraw the funds.
Using Your IRA to Support the Causes You Care About
If you like to donate to hospitals, religious organizations, educational institutions, or other nonprofits, there is a strategy that may allow you to meet charitable goals while potentially reducing taxable income and meeting your RMD requirement.
How a Qualified Charitable Distribution Works
It is called a qualified charitable distribution, or QCD. Beginning at age 70 ½, an eligible IRA owner can direct a QCD from an IRA to an eligible charitable organization you care about. That distribution can count toward your required minimum distribution once RMDs apply, and it is excluded from taxable income. A QCD can satisfy all or a portion of your RMD while directing funds to a qualified charitable organization.
For the right client, a QCD can be a tax-efficient way to make a charitable contribution. If you have to take the money out of your IRA anyway, a QCD allows you to direct those funds toward a cause you care about while potentially reducing your taxable income compared with taking the RMD and then making a charitable contribution.
Other Strategies to Review
There are other approaches as well. The timing of your distributions, having taxes withheld directly from the RMD so there is no surprise in April, and reinvesting what you do not need into a non-retirement account are all worth a look. The right strategy depends on your individual financial situation, your goals, and your tax considerations.
RMDs are required, but there may be planning opportunities worth exploring. Careful planning can help you evaluate distribution options, understand potential tax implications, and make informed decisions about your retirement income.
Frequently Asked Questions
When do required minimum distributions start?
Under current rules, the applicable RMD age depends on your date of birth. SECURE 2.0 sets the RMD age at 73 for individuals who reach age 73 before 2033 and 75 for younger individuals who reach age 74 after 2032. The amount is based on your prior year-end account balance and an applicable life expectancy factor. The IRS sets these rules, and they can change.
How is a required minimum distribution taxed?
RMDs from traditional retirement accounts are generally taxed as ordinary income, except for amounts that may represent previously taxed contributions or other tax-free amounts. Because an RMD generally counts as income, it can push a portion of your income into a higher tax bracket, increase the tax on your Social Security benefits, and raise your Medicare premiums.
What is a qualified charitable distribution?
A qualified charitable distribution, or QCD, sends money directly from an eligible IRA to a qualified charitable organization. For an eligible IRA owner age 70½ or older, the distribution is generally excluded from taxable income and can count toward an RMD once RMDs apply, so it can satisfy all or a portion of your RMD while supporting a cause you care about.
Schedule a Complimentary Introductory Meeting
Apex Wealth Management Group serves clients across the country from its office in Orange County, California. If you are within 10 years of retirement, or already taking distributions and you’re unsure how they fit into your overall retirement and tax-planning picture, the firm welcomes a conversation about your situation. There is no cost for an introductory meeting and no obligation to work with the firm afterward.
The best place to start is at apexwmg.com, where you can read more about the team and the services offered, or reach out to schedule a time to talk. You can also call the office at (714) 919-4446.
This information herein is for educational purposes only and should not be construed as investment, legal or tax advice. Please consult your investment, legal, and tax professional regarding your individual situation. Securities offered through Kovack Securities Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Suite 1201, Ft. Lauderdale, FL 33308 (954) 782-4771. Investment Advisory services are offered through Kovack Advisors, Inc. Apex Wealth Management Group is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc.