Two Alternatives to Required Minimum Distributions (RMDs)

Here’s my simple explanation of required minimum distributions (RMDs): At age 73 or 75 (if you were born in 1960 or after), Uncle Sam knocks on your door and asks you to pay taxes on your tax-deferred investments. You’ve gone perhaps years without paying taxes on these accounts, and he’s $36 trillion in debt. In more technical terms, an RMD is when you take out a specific percentage (based on the IRS life expectancy table) from your tax-deferred investments (401(k)s, IRAs, etc.) and pay taxes on it.

The older you get, the more that percentage increases. Most retirees not only see an increase in that percentage, but they also see their investments grow. This combination may cause you to take out significantly more in the future, which can create issues when it comes to paying taxes. It could push you into a higher tax bracket, cause Social Security to be more taxable, raise your Medicare premiums and cause capital gains to be taxable or more taxable.

Now, what if you don’t want to take your RMD? Can you just pass on it? You do not want to do this, as the penalty is a 25% tax. I know not everyone wants to take out their RMD, but this is something you don’t want to miss. Luckily, there are a few ways to make RMDs a little less troublesome.

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Strategy No. 1: Roth conversions

You could deal with this now by reducing your RMDs in the future. This could involve taking money from your tax-deferred investments before age 73 or 75 or utilizing a Roth conversion strategy. A Roth conversion is when you take money from a tax-deferred investment and move it to a Roth IRA.

With this strategy, you have to pay taxes when you move the money, but it can make a lot of sense while tax rates are low and before that investment has the opportunity to grow more. When your money is in a Roth IRA, you are not required to take out RMDs, which allows your money to grow tax-free. Also, all the money you take from this account will be tax-free and not count as income, as long as you are 59½ or older and have had a Roth open for at least five years.

Joe F. Schmitz Jr., CFP®, ChFC®

Joe has built a comprehensive retirement planning company focused on helping clients grow and preserve their wealth. Under his leadership, a team of experienced financial advisers use tax-efficient strategies, investment management, income planning and proactive health care planning to help their clients feel confident in their financial future — and the legacy they leave behind.

Please note that if you’re 73 or 75 or older and taking RMDs, you can still do a Roth conversion, but you have to take your RMD out first before you do a conversion. For example, if you are required to take $10,000 from your IRA, but you want to do a $5,000 Roth conversion, you would take out $10,000 first (which cannot be converted). You would then convert $5,000 on top of that, which means your total taxable withdrawal amount would be $15,000.

Strategy 2: Charitable donations

For my charitable clients who don’t need to live off their RMDs, we recommend they gift their RMD or a portion to a charity. This strategy is tax-free for you and the charity. It’s called a qualified charitable distribution (QCD).To make a QCD, send the money straight to the charity so it doesn’t get counted as income.

I remember one of my clients was giving $10,000 to his church every year and was in the 22% tax bracket. He would take out about $12,200 from his IRA each year and then give it to the charity. It did not go straight to the charity. In doing this, he gave only about $10,000 after taxes. He came to me, wondering what he should do with his RMD since he didn’t need the full amount. What a perfect opportunity. I told him to do a QCD and give the money straight to his church. Doing so saved him about $2,200 that year! That is the power of a QCD if you are charitable-minded.

Don’t pay more than you need to

So, next time Uncle Sam comes knocking on your door, you will be a little more educated and hopefully have a better plan to keep your hard-earned money instead of tipping Uncle Sam and paying more than your fair share. And don’t forget that a financial professional you trust can be incredibly helpful in this situation.

Investment Advisory Services and Insurance Services are offered through Peak Retirement Planning, Inc., a Registered Investment Adviser.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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