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Anyone with a 401(k), traditional IRA or similar tax-deferred retirement account eventually is going to face the requirement to start taking required minimum distributions (RMDs) from their accounts. The IRS has allowed you to have what can be decades of tax-free growth in the account, along with years of tax deductions, so they eventually requiring you to start paying those taxes, regardless of whether you need the funds or not.
Starting at age 73 in 2024 (RMD age moving to 75 in 2033), the law says you must take a certain amount of money out annually, and it’s based on how the IRS sees your life expectancy. If you fail to take your RMD, the penalty is a whopping 25% of the amount you didn’t withdraw (can be lowered to 10% if rectified within two years).
Do you have questions about planning for RMDs? Speak with a financial advisor today.
For someone who doesn’t need the cash from an RMD to cover living expenses, the issue becomes not only what to do with the money, but also how to minimize taxes. This is important because RMDs can induce a number of different tax increases across your life.
For instance, you’ll first face paying taxes on the withdrawal as ordinary income. Then, depending on the amount of your RMD, you could have enough total income to trigger taxes on up to 85% of your Social Security benefits. A higher income also could increase your Medicare premiums, which are subject to an income-related monthly adjustment amount (IRMAA) surcharge.
There are a few strategies you can use to minimize or avoid taxes on your RMDs, including the following:
The simplest approach is to donate some or all of the money to a qualified charity as a Qualified Charitable Distribution, or QCD. In this case, you never touch the money because it goes directly to the charity, meaning you won’t face any tax on the donation. This works only if the money is sent directly to the charity – you can’t withdraw it and then donate it yourself – and you also need to make sure the charity meets IRS rules in order to be considered qualified. The IRS limits QCDs to $105,000 for 2024.
If you’re still working and have a 401(k) at your current employer, you aren’t required to take an RMD from that account, and that account only. This could be a good reason to roll over money from previous 401(k)s into your new employer’s plan, rather than into an IRA. Otherwise, you’re required to take a taxable RMD from each one of those older 401(k)s.
