Maximizing Your Retirement Savings: Smart Strategies for Managing RMDs

Tax-deferred retirement accounts like 401(k)s and traditional IRAs allow you to lower your taxable income during your working years. The Internal Revenue Service (IRS) mandates required minimum distributions (RMDs) for these accounts to ensure that investors do not defer paying taxes on their retirement savings indefinitely. The amount investors must take is determined by dividing the retirement account’s prior year-end fair market value by a life expectancy factor published by the IRS.

Thankfully, the government has pushed back the beginning date for required withdrawals; the first RMD must be taken by April 1 of the year after the account owner turns 73 years old if their birth date is from 1951 to 1959, or age 75 if born in 1960 or later. Failure to take the required distribution results in an excise tax of 25% of the amount not withdrawn. However, the penalty could be lowered to 10% if the withdrawal is corrected in a timely manner.

Ideally, investors would be tapping their retirement assets for living expenses. However, many investors end up with substantial retirement account portfolios but live below their means or have a diverse income stream, such as a pension from a previous employer, Social Security benefits, rental income from investment properties, and interest and dividends from a taxable investment account. When monthly living expenses are comfortably covered, mandated distributions can result in excess cash sitting idle that likely won’t generate a competitive return in a checking account.

Investors fortunate enough not to need all the money they’re required to withdraw in their senior years have plenty of options to make the money work wisely. They may consider transferring the required withdrawal from the retirement account to a taxable brokerage account and reinvesting it according to a strategy that aligns with their financial goals.

Generous investors have several options. In 2024, taxpayers are allowed to give up to $18,000 for singles ($36,000 for married couples filing jointly) per recipient per year without incurring gift tax or using up their lifetime estate tax exemption. Investors may also pay certain expenses for family and friends without triggering gift tax issues. Paying medical bills or tuition is not considered a taxable gift, provided the payment is made directly to the medical practice or college. Investors can also fund a 529 Plan for younger relatives or friends. Contributions to 529 Plans are considered gifts but may qualify for state income tax deductions or credits. Another beneficial option is to make charitable donations through a Qualified Charitable Distribution (QCD). By directing IRA funds straight to a qualified charity, investors can satisfy RMD requirements while still receiving a tax benefit, as the donation is excluded from taxable income.

Through comprehensive planning, some may discover several years before their RMD beginning date that they will not need to rely on it. These investors may consider converting a portion of their IRA assets to a Roth IRA. Taxes would be due on the conversion, but future growth in the Roth IRA account should be tax free when withdrawn. This move can gradually reduce traditional IRA balances and could be a valuable estate planning tool to pass assets tax free to heirs. Roth conversions can also help reduce the size of the taxable estate if the estate expects to be subject to estate taxes.

If you have questions on how to use your required minimum distribution once living expenses are covered, the experts at Henssler Financial will be glad to help: