We constantly remind taxpayers to save to tax deferred accounts during their working years to save for retirement. Part of the pitch is that contributions lower your adjusted gross income and defer the tax due until many years into the future. Eventually that day comes when you must pay the taxes. For some, it happens gradually as they tap their retirement accounts once they quit working. For others, it’s a half-birthday “gift” from your younger self and the IRS when you turn 70½.
The IRS requires account owners to withdraw required mandatory distributions (RMD) once you reach age 70½. As the saying goes, “You can’t take it with you,” so when it comes to your tax deferred retirement accounts, you either take the withdrawal and pay the taxes, or pay a merciless penalty of 50% of the amount not withdrawn, in addition to the tax that is due on the withdrawal.
Ideally, investors should begin consulting experts several years prior to when they must take RMDs because a significant increase in income can affect taxes in a meaningful way. An increase in modified adjusted gross income can cause your Social Security benefits to be taxed at the maximum percentage, and subject you to a Related Monthly Adjustment Amount for Medicare costs.
If you’ve come to the conclusion that you don’t want to give all of your money to the IRS through penalties, what do you do with your required minimum distribution if you don’t need it to live on? Start with some basic financial planning. Make sure you have an emergency reserve fund. Depending on the size of your RMD, you may be able to self-insure any long-term care needs, eliminating the need for long-term care insurance, with the emergency fund you’ve saved. You can also pay off any debt, including medical, mortgage or home equity loans. Erasing this debt can help your monthly cash flow, leaving you with more discretionary money.
You can use your retirement money to make more money by investing your RMD into a taxable account, assuming you have a long-term time horizon of at least 10 years before you intend to spend the money. If you’re fortunate enough to know you will not need to rely on your RMD several years prior to turning 70½, you may consider converting a portion of your IRA assets to a Roth IRA. While taxes would be due on the assets converted, any future growth in the Roth IRA account should be income tax free when withdrawn. The added benefit to starting this while in your 60s is that you’ll be reducing your IRA balance and potentially reducing your future RMD. Furthermore, Roth IRA assets are not subject to required minimum distributions later.
If you don’t need your RMD for your living expenses, you can pay certain expenses for your family without incurring any gift tax issues. You can pay medical bills or tuition for anyone provided you pay the medical practice or college directly. These are not considered taxable gifts, so if you still wanted to gift your wealth to those same individuals—up to $15,000 for singles or $30,000 for married filing jointly—you could do so. You could also fund a 529 Plan for a younger relative.
Another beneficial option is to direct a portion or all of your required minimum distribution to a qualified charity. You will not receive a charitable contribution deduction on your taxes, but you also won’t have to pay taxes on the amount given directly to the charity. Donating a substantial portion of your RMD can help you control your taxable income.
If you have questions regarding your required minimum distributions, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is for demonstrative and academic purposes and 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.
