How to Reduce Your RMDs

When most people begin seriously thinking about retirement, their traditional 401(k) plan is oftentimes their largest source of retirement income. Saving to a traditional 401(k) or IRA is a great way to build a nest egg for retirement. However, as our friend Ed Slott, CPA frequently says, there’s a retirement savings tax time bomb that can blow up your retirement if you’re not careful. A big part of that time bomb is Required Minimum Distributions, so we’re going to outline a few strategies for how to reduce your RMDs.

What Are RMDs?

Before we discuss how to reduce RMDs, we need to explain what RMDs are. If you have $X amount saved in a traditional 401(k) or IRA, you must remember that all that money isn’t yours because it won’t be taxed until you access it. And it isn’t as simple as stockpiling money into tax-deferred accounts and then passing it on to the next generation to avoid being taxed on that income. That’s where RMDs come into play. RMDs are the minimum amount that you need to withdraw from your retirement account or IRA each year.

The age to start taking RMDs was moved from 72 to 73 when the SECURE Act 2.0 became law on January 1, 2023. You must start withdrawing funds from your traditional retirement accounts by April 1 of the year after you turn 73. It’s then set to increase to 75 by 2033. But don’t wait until you’re approaching your RMD age to start planning for RMDs. You need to start thinking about RMDs as a part of your retirement before and after you retire.

The bottom line is that you’ve worked hard for your money. We want you to understand how to properly save and manage your money to help reduce your overall tax liability. So, let’s look at five strategies for how to reduce your RMDs.

1. Roth Conversions

Number one on our list for how to reduce RMDs is Roth conversions. Simply put, there are no RMDs for Roth IRAs. You are required to pay tax on the conversion, but that could be well worth it for you with no longer being subject to RMDs.

We should note that your beneficiaries will still need to take RMDs from inherited Roth IRAs and liquidate them within 10 years after the year of your death. Fortunately for them, though, those distributions will be tax-free as long as you held the Roth IRA for at least five years.

The tax-free distributions are one of the pros of Roth conversions, but there are some cons that people need to be aware of as well. For example, did you know that Roth conversions could throw you into a higher Medicare IRMAA bracket? Make sure to consult with a tax professional if you’re considering a Roth conversion to see if it makes sense for you. It’s important to make sure that Roth conversions fit within your overall tax strategy. Download our Roth Conversion Case Studies to review additional Roth conversion considerations.

Roth Conversion Case Studies

When our team takes clients through the planning process, we look at all sources of income. This is the time to take the collection of everything that you’ve saved and put it in a format to produce income for you. However, in doing that, you need to include tax efficiency. That’s why our CFP® Professionals collaborate with our CPAs to make sure each client’s comprehensive financial plan is reviewed for potential tax planning opportunities. It’s our goal to help reduce your tax liability over the course of your lifetime, not just on a year-by-year basis.

2. Qualified Charitable Distributions

If you’re charitably inclined and 70½ or older, you may not want to convert all of your IRA to a Roth IRA so you can take advantage of Qualified Charitable Distributions. That way you can get money out of your IRA and give it directly to charity without it ever showing up on your tax return.

So, QCDs can be a strategy for how to reduce your RMDs. Through QCDs, you can transfer up to $105,000 per year from your IRA to a charity tax-free. And that’s not all. QCDs also satisfy your RMDs and are therefore a popular tax planning strategy.

To learn more about tax planning strategies such as QCDs and Roth conversions, download our Tax Reduction Strategies guide below.

Tax Reduction Strategies

3. Strategically Managing Your IRAs

If you are under 59½ and take an early withdrawal from your IRA, there’s a 10% penalty that comes with it. However, there are 20 exceptions. That’s another article and podcast in itself, but when you get a chance, take some time to review those 20 exceptions. Unless you’re trying to get an early withdrawal, ages 59½ to 73 (RMD age) is the ideal timeframe to do IRA planning.

After you turn 59½, that money is yours to access penalty-free if you choose to take a distribution. When trying to figure out how to reduce your RMDs, make sure that you’re strategically managing your IRAs during this timeframe.

Tax Bracket Management

Let’s run through an example of how to strategically manage your IRAs for a couple that is married filing jointly and need to have $7,000 a month to spend. When you combine your Social Security withdrawals from your IRAs, etc., you get that $7,000 a month. What someone might not understand is that even though they may only need $84,000 a year, they may want to take extra out of the IRA that year and pay the taxes on it to go all the way to the top of the 12% tax bracket. They can go all the way up to $96,950 of taxable income and get money out in that 12% bracket in 2025.

But why would you do that? You need to look forward and figure out what tax bracket you’re going to be in when RMDs are forced on you. Can you get the money out earlier in retirement at a lower tax bracket than what you will be forced to take it out in the future?

That’s an active thing that people need to look at every year. Don’t just say, ‘Well, this is all I needed, so that’s all I took out.’ If you know the event is going to take place as the year progresses, know those thresholds so that you don’t need to pay any more tax than necessary. You can do that by adjusting how often you take them and when you take them. It’s a situation that is somewhat controllable.

4. Delaying When You Take Social Security

It isn’t too long after you turn 59½ that you become eligible to start claiming Social Security (age 62). There are a lot of people who want to take Social Security ASAP and then retire. It’s critical to remember, though, that the longer you delay claiming Social Security, the bigger the benefit.

If you can delay claiming Social Security, you can withdraw from your retirement accounts in a manner that you can reduce your tax liability over time. That’s why delaying Social Security came in at number four on our list for how to reduce your RMDs.

Social Security is going to impact how much you can convert from a traditional IRA to a Roth IRA. The more Social Security you have early in retirement, the less you can convert and stay in that 12% or 22% bracket. So, when you think about Social Security claiming, it also goes back to what your RMDs are going to be. If you delay when you claim Social Security, does that allow you to get more money to Roth accounts prior to the RMD so that it reduces that?

Remember that Social Security is taxed differently than any other asset. There’s something called provisional income that comes into play when calculating how much of your Social Security benefits are taxable. Your provisional income is determined by calculating the sum of 50% of your estimated Social Security annual benefit, your gross income, and any tax-free interest that you have.

If you’re a single filer and your provisional income is between $25,000 and $34,000, 50% of your benefits will be taxable. If it exceeds $34,000, 85% of your benefits will be taxable. The provisional income thresholds to keep in mind if you’re married and filing jointly are $32,000 and $44,000. Make sure you’re aware of how to calculate your provisional income as you’re planning for RMDs and determining how to reduce them.

5. Qualified Longevity Annuity Contracts (QLACs)

Our fifth strategy for how to reduce your RMDs is through a Qualifying Longevity Annuity Contract (QLAC). QLACs are designed to help with longevity concerns. Any funds you invest in the QLAC aren’t included in your balance when calculating RMDs until you turn 85.

There were some SECURE 2.0 that made QLACs easier to purchase.1 Those provisions made it possible to defer more taxes and purchase additional retirement income from your 401(k)/IRA. Prior to SECURE 2.0, you could buy a QLAC with the lesser of 25% of your retirement funds or $125,000. The 25% limit was applied to each employer plan separately, but in aggregate to IRAs. Now, the maximum QLAC is up to $200,000 per person with a 0% savings limit.

We always want to make sure that investment decisions like QLACs, Roth conversions, Qualified Charitable Distributions, etc., are vetted specifically for your needs by fiduciary professionals. We are fiduciaries at Modern Wealth and take the commitment of putting our clients’ needs first very seriously.

Another Obvious Option: Continue Working

There is one more effective option for how to reduce your RMDs that we purposely left off our list. That’s to continue working. While that is a strategy for how to reduce your RMDs, we want you to have a financial plan that can help you determine when you’ve become financially independent.

If you enjoy your job and want to keep working, that’s great. But once you’ve achieved financial independence, you should be doing the things you want to do for the reasons you want to do them, and not because you need a paycheck.

The Importance of Planning for RMDs Before and After Retirement

This is why it’s so critical to plan for RMDs before and after retirement. We don’t want that retirement savings tax time bomb to blow up your retirement, so let’s start planning. If you’re ready to start talking about how to reduce your RMDs, start a conversation with our team below. Let’s look at how we can reduce your RMDs to help you confidently get to and through retirement.

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[1] https://www.kiplinger.com/retirement/qlac-secure-act-gives-this-annuity-a-boost

Investment advisory services offered through Modern Wealth Management, Inc., a Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management a Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.