How to Reduce RMDs with 5 Strategies

By Chris Duderstadt

August 21, 2023

How to Reduce RMDs with 5 Strategies

Key Points – How to Reduce RMDs with 5 Strategies

  • What Are RMDs and How Do You Reduce Them?
  • Understanding the Latest RMD Rules
  • Planning for RMDs Before and After Retirement
  • 7 Minutes to Read | 23 Minutes to Watch

How to Reduce Your RMDs

When most people begin seriously thinking about retirement, their employer provided traditional 401(k) is oftentimes their largest asset. 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 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 a traditional 401(k) or IRA, you have a partner in those accounts in Uncle Sam. Unfortunately, you can’t keep your money in those accounts forever because Uncle Sam is entitled to his piece of it. You must begin withdrawing funds from those accounts—hence RMDs.

In December 2022, the age to start taking RMDs was moved from 72 to 73, beginning on January 1, 2023, thanks to the SECURE Act 2.0. 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. According to the IRS, “a RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes in tables in Publication 590-B.”

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 so that Uncle Sam’s piece of the pie is as small as possible. So, let’s look at five strategies for how to reduce your RMDs.

“You should be thinking about RMDs as a part of your retirement plan not only after you retire, but before you retire.” – Dean Barber

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. Fortunately for them, though, those distributions will likely be tax-free.

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 bracket? Make sure to consult with a tax professional if you’re considering a Roth conversion to see if it makes sense for you.

“When you think about doing Roth conversions prior to RMDs, not only does it need to fit into your financial plan and not disrupt your probability of success of living the way you want to live your entire life, it needs to fit into your overall tax strategy. There’s an art form to this that requires the CFP® Professional to produce the plan and then have the CPA look at it from a tax perspective.” – Dean Barber

When we’re going through the planning process, we’re looking at all sources of income. This is the time you 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 we work directly with the CPAs in our firm to direct that income in the least taxing way possible.” – Bud Kasper

2. Qualified Charitable Distributions

You want to be careful doing Roth conversions in retirement if you’re charitably inclined. 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 $100,000 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. Remember that everyone’s goal should be paying as little tax as possible over your lifetime, not just in one year.

How to Reduce RMDs

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 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 $5,000 a month to spend. When you combine your Social Security withdrawals from your IRAs, etc., you get that $5,000 a month. What someone might not understand is that even though they may only need $60,000 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 $90,000 of taxable income and get money out in that 12% bracket.

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 have room in that tax bracket, managing the IRAs and the distributions on those IRAs can allow you to get the money out of that account. Yes, it’s coming out a little early, but you’ll be paying taxes on it at a lower rate.” – Dean Barber

Paying Taxes in Tiers, Not Tears

The thing to do is to plan for RMDs. 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 do that by simply adjusting how often you take them and when you take them because it’s a situation that is somewhat controllable.

A lot of people look at the various brackets and say they’re in the highest bracket, but they’re not because you pay taxes in tiers. That’s t-i-e-r-s, not tears. That’s what we call your effective tax rate.

If you understand that, that helps you understand what liabilities you will have from a tax perspective. It gives you some better insight as to how you want to tactfully not go over certain thresholds. That crosses over into Medicare, too.

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 mitigate your taxes over time. That’s why delaying Social Security came in at number four on our list for how to reduce your RMDs.

One thing that drives Bud crazy is when somebody says that Social Security isn’t going to be here and that they need to get it out as fast as they can. He believes that is a huge mistake.

“Every year you delay, you’re getting a higher amount of benefit. You also need to reflect on what the taxes are going to be associated with it.” – Bud Kasper

Social Security is going to impact how much you can convert from a traditional to a Roth. 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 it, does that allow you to get more money to a Roth prior to the RMD so that it reduces that? And remember that Social Security is taxed differently than any other asset. It’s a tool and it’s taxed differently, so it needs to be factored in when thinking about RMDs and 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 provisions in SECURE 2.0 that made QLACs easier to purchase. Thanks to SECURE 2.0, you can 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.

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 give you more confidence, freedom, and TIME in retirement. If you enjoy your job and want to keep working, that’s great, too. 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, we’re ready to help. You can schedule a 20-minute “ask anything” session or complimentary consultation with a CFP® Professional by clicking here. We can meet with you in person, virtually, or by phone depending on what works best for you. Let’s look at how we can reduce your RMDs to help you go to and through retirement with clarity and confidence.

How to Reduce RMDs with 5 Strategies | Watch Guide

00:00 – Introduction
01:55 – RMDs Before & After Retirement
03:30 – 5 Ways to Reduce RMDs
04:21 – Roth Conversions
07:18 – Qualified Charitable Distributions
08:15 – Tax Reduction Strategies
08:39 – Top Three Reasons to Consider RMDs Before Retiring
09:33 – Strategic Account Management
15:15 – Delaying Social Security
18:30 – Qualified Longevity Annuity Contract
19:57 – Bonus Strategy
21:00 – What Did We Learn Today

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. 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.