The government allows taxpayers to put away money during their lifetime into 401(k) accounts or traditional IRAs, deferring the tax due on the growth and income until the money is withdrawn. Because the IRS wants investors to pay the taxes on this money, they require account owners to withdraw a percentage of the assets once they turn 70½. The required mandatory distribution (RMD) is the balance as of December 31 of the prior year, divided by a life expectancy factor. The factor is found on tables published by the IRS—the Uniform Lifetime Table, Joint and Last Survivor Table, or the Single Life Expectancy Table, found in Publication 590, Individual Retirement Arrangements.
By the end of the year, account owners must have withdrawn that amount from their accounts. The penalty for not withdrawing the correct amount is merciless: 50% of the amount not withdrawn, in addition to the tax that is due on the withdrawal.
At Henssler Financial, we believe this is one area where professional help, whether from a financial adviser or a tax consultant, is worth the cost. Ideally, investors should begin consulting experts several years prior to when they must take RMDs. Not only can calculating RMDs be complicated—and costly if done incorrectly—but a significant increase in income can affect taxes in a meaningful way. At 65, many retirees are receiving Social Security and are able to live comfortably on that income plus the income generated by their fixed-income portfolios. Taking distributions from an IRA can increase how much of the Social Security benefit is taxed. Even if Social Security benefits are taxed at the maximum percentage, an increased modified adjusted gross income from an RMD may subject individuals to a Related Monthly Adjustment Amount for Medicare costs.
One strategy may be to begin withdrawals between 65 and 69 to lower the IRA balance. In Georgia, taxpayers 65 and older are eligible for the Retirement Income Exclusion, meaning up to $65,000 of income is free from Georgia state income tax. While IRA distributions would still be taxable on a federal level, retirees could save the 6% state tax on their IRA withdrawals. By withdrawing funds prior to age 70 ½, the IRA balance will decrease, making the mandatory withdrawals at 70 ½ less.
IRA owners may also consider converting a portion of the IRA to a Roth IRA. Some investors may be in a position where they could convert some of their money, remain in a low tax bracket, and then have assets that are not subject to required minimum distributions later. While taxes would be due on the assets converted from an IRA to a Roth IRA, any future growth in the Roth IRA account should be income tax free and not subject to required distributions. A strategy like this may factor into a taxpayer’s estate planning wishes.
One problem we often see is many investors are so concentrated on their tax savings that they do not focus on maximizing their return after taxes. For example, there are those who would rather earn 1% tax free rather than 4% that is taxed at 50%. Overall, there are many strategies for managing required minimum distributions and taxes in retirement, but not one that works for all. The strategy that works best should be tailored to your situation.
If you have questions regarding how RMDs will affect your taxes, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
