These 4 Strategies Can Reduce Your RMDs

Key Takeaways

• Traditional tax-deferred accounts that you own in your own name are going to be subject to required minimum distributions.
• To reduce RMDs, you should first prioritize Roth contributions.
• Roth contributions can be preferable to traditional tax-deferred ones, but some people still don’t have a Roth option for their company retirement plan.
• Converting traditional IRA assets to Roth is the second strategy to reduce RMDs.
• After retirement and before the RMD years can be a good time to accelerate withdrawals from a tax-deferred account despite triggering a tax bill.
• Qualified charitable distributions can be another way to reduce RMDs.

Margaret Giles: Hi, I’m Margaret Giles from Morningstar. Many baby boomers will be coming into retirement with most of their assets in tax-deferred accounts, which require withdrawals called required minimum distributions at age 73. Joining me to share four strategies for reducing those RMDs is Christine Benz. She’s Morningstar’s Director of Personal Finance and Retirement Planning. Christine, thanks for being here.

Christine Benz: Margaret, great to see you.

Which Accounts Are Subject to RMDs?

Giles: So let’s start with the basic question, which accounts are subject to RMDs and which avoid them?

Benz: Generally speaking, traditional tax-deferred accounts that you own in your own name are going to be subject to those required minimum distributions. So they don’t apply anymore to inherited IRAs. There are new rules around inherited IRAs. But if you have those traditional tax-deferred accounts, whether IRAs, SEP IRAs, company retirement plan assets, they will all be subject to RMDs. And then in the big category that is not subject to RMDs, those would be Roth accounts. So Roth IRAs, Roth 401(k)s, and also taxable brokerage accounts. So, accounts that you’re paying taxes on the money going in, you’ll potentially owe capital gains on the way out, but there are no strictures around how much you can put into a taxable brokerage account or how much has to come out and when.

How to Reduce RMDs

Giles: So let’s delve into the strategies for reducing RMDs. And the first is only applicable to those who are still working. What is it?

Benz: The first is to prioritize those Roth contributions, whether to an IRA or a company retirement plan that has Roth contributions available. The beauty of that, as I just said, is that they are not subject to required minimum distributions. And provided that you follow the rules around keeping your money in the right amount of time and so forth. They will not be subject to taxes upon withdrawal either. So a lot of advantages to looking to Roth.

Are Roth Contributions Preferable to Tax-Deferred Ones?

Giles: So are Roth contributions always preferable to traditional tax-deferred ones?

Benz: It depends on who you ask. If I were to ask Ed Slott this question, he would say yes, almost always you should prioritize the Roth. The issue is that some people, it’s a shrinking share, but some people still don’t have a Roth option for their company retirement plan. So that might be in the mix. And then another good case of when traditional tax-deferred contributions might be better is if someone is kind of later in their career, they’re in their peak earnings years, but they haven’t yet set much aside for retirement. That tax break when their taxable income is at a relatively high level is more valuable to them. Then it will be in retirement. So it may be valuable if they can get a tax break on their contributions to prioritize those traditional tax-deferred contributions.

How Converting Traditional IRAs to Roth Can Reduce RMDs

Giles: Right. So converting traditional IRA assets to Roth is the second strategy to reduce RMDs. Now you think that conversions often make sense in that life stage between retirement, but before age 73, when RMDs start. So why is that life stage such an opportune time to convert?

Benz: Right. There may be oddball years where you’re working, but for whatever reason, your income is lower. And those might also be good years to consider conversions. But retirement planners often say that post-work, pre-RMD, pre-age 73 now is a real sweet spot to consider those conversions. And the key reason is that you have a lot of control over your taxable income in those years. They may be kind of the high spending years of your retirement, but if you can curtail how much you’re spending, how much taxable income you have, that means that you can convert portions of your balance at a lower tax rate. So that’s why it’s a terrific window to look at potentially doing some conversions in that particular period because you You can get money moved over. to the Roth column and of course you’ll pay taxes to do those conversions, but you’ll pay taxes that are at a relatively lower rate than you might if you’re still working or if those RMDs have commenced and they’re already high.

How Much Should You Convert to Roth?

Giles: So, how can people go about figuring out whether and how much to convert?

Benz: Yeah, this is not back-of-the-envelope time. This is a really good spot to get some financial advice. Even if you’re pretty comfortable in tax matters, there are a lot of indirect tax effects that can come into play with these conversions, especially for people who are covered by Medicare, the IRMAA, the income-related Medicare adjustment amount, can come into play. With the SALT tax limits and the fact that they are tethered to income now, that’s also in the mix. So I would definitely get a little bit of advice before proceeding. And a good financial planner or tax advisor can help you figure out how much to convert each year to avoid knocking yourself into a higher tax bracket. So it can be a little bit delicate. So I think it is a super good place to pay for advice or use some sort of tax planning software, just so you’re certain about what the tax effects might be.

Why Retirees Should Accelerate Withdrawals Before They Have to Take RMDs

Giles: So you also think that those postretirement, pre-RMD years can be a good time to accelerate withdrawals from a tax-deferred account despite triggering a tax bill. So that’s the third RMD reducing strategy. What’s the benefit there?

Benz: Well, the benefit is that by taking money out of the IRA or company retirement plan and paying tax on it in those lower tax years, you are, you know, kind of taking the tax hit at a good time at a relatively low tax rate. And then, importantly, you’re also shrinking the balance that will eventually be subject to RMDs. So you’re putting a little bit more control over how much your RMDs are. That can be a valuable strategy to consider sometimes in conjunction with conversions that maybe you’re also taking some of your withdrawals from those traditional tax-deferred accounts.

How Qualified Charitable Distributions Can Reduce RMDs

Giles: So the fourth and final strategy here is the qualified charitable distribution. Who’s eligible and how does it work?

Benz: Right. There’s a little bit of a disconnect because you can start doing the QCD at age 70 and a half. You don’t have to wait until your RMD age, which is 73. And the virtue of the QCD is a couplefold. One is that if you’re charitably inclined, you can take a portion of your IRA balance and send it to charity. And importantly, you won’t owe taxes on the amount that you have contributed to charity via the QCD. And you’ve also shrunk your RMD subject balance. And once RMDs come online, once you’re 73, it’s subject to RMDs. The QCDs that you make will fulfill your RMDs. The specific amount that’s available for QCDs has been a little bit of a sliding scale. We’ve seen an inflation adjustment. It’s now over $100,000. So you can make significant charitable contributions, and it will tend to beat taking money out of, say, a taxable account by writing a check to charity. It’ll tend to be better for you on a taxable basis than doing that. Doing the QCD will tend to be preferable in almost every situation.

Giles: All right. So, four helpful strategies to think about. Christine, thanks for taking the time.

Benz: Thanks so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch How to Protect Your Finances if You Need to Retire Early for more from Christine Benz and Margaret Giles.