Downsize Your Required Minimum Distributions

There are so many decisions you have to make when you’re planning for retirement, it can be tempting to delay the ones that seem as though they can wait.

Take, for example, the required minimum distributions (RMDs) you must begin withdrawing from your tax-deferred investment accounts at age 70½. Dealing with the tax consequences of those withdrawals may seem a long way away when you’re in your late 50s or early 60s, but there are strategies you can put into place now that could save you thousands of dollars later.

Could You Be Headed for a $90,000 RMD?

I often meet with people who proudly tell me they have $1 million or more saved for retirement in an IRA, and I hate to be the one to burst their comfort bubble with a sad reminder that it isn’t all theirs. Uncle Sam isn’t going to put off getting his share forever. Eventually, you have to start paying taxes on that money.

And the older you get, the more you’ll be required to withdraw. RMD percentages, which are based on your age, increase every year. At age 70½, the RMD on $1 million would be less than $40,000. At age 90, it’s almost $90,000. (Think you won’t live that long? According to the Social Security Administration, about one out of every four 65-year-olds today will live past 90, and one out of 10 will live past 95.)

Add that amount to your Social Security benefits and any pension or other income you have, and you easily could jump to a higher tax bracket. If your income exceeds a certain threshold (determined by your filing status), a percentage of your Social Security and Medicare benefits also may be considered taxable.

Two RMD-Busting Strategies

So how can you avoid RMDs? This is where proactive planning can save you.

• Take distributions before you’re forced to. After age 59½, it may make sense to begin taking penalty-free distributions from a traditional IRA, instead of waiting until you’re 70½. The goal is to manage your retirement account with small withdrawals now to avoid income spikes from your RMDs later. You want to fill the lowest tax bracket you can without bumping yourself up to the next tax bracket. To recoup the taxes paid as quickly as possible, you could use an indexed universal life (IUL) policy because of higher caps, which allows us to grow it with a safety net. Or you could put the withdrawn funds into long-term investments that will sweeten your later years — or your legacy.
• You could convert money in a traditional IRA into a Roth IRA. There are no RMDs from a Roth account while the owner is alive. You will, of course, have to pay taxes on the amount that you convert. If you start in your 60s, you’ll have plenty of time to do this in small amounts to better spread out the tax bill. Or you can do a lump-sum rollover and take a one-time tax hit. That won’t be pleasant, but going forward, your money will grow tax-free.

Most people look at RMDs as something to worry about long after they’ve decided when to stop working, when to take their Social Security benefits and other pressing, but more positive, retirement questions.

But, believe me, your future self will thank you if you put it on your list of things to talk about the next time you meet with your financial adviser.

Kim Franke-Folstad contributed to this article.

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