When it comes time to start taking required minimum distributions (RMDs), you may discover that it could put you into a higher tax bracket. RMDs can be sizable. If you are retired or getting ready to retire, you must take them when you reach a certain age.
After the SECURE 2.0 Act (setting every community up for retirement enhancement) passed, you must start taking RMDs if you have the following traditional retirement accounts:
- IRAs (individual retirement accounts)
- SEP (simplified employee pension) IRAs
- SIMPLE (savings incentive match plan for employees) IRAs
- and most other retirement accounts
Penalties for Failure to Take RMDs
Penalties for not taking an RMD when you should can be rather expensive. Failure to make an RMD or not withdrawing the entire amount (you can take more than required), the Internal Revenue Service (IRS) says, will result in a 25 percent penalty of the RMD that you did not withdraw—unless corrected within two years, then it may be reduced to 10 percent. You will also have to pay a tax bill on the amount withdrawn.If you are looking for a way to delay taking your RMDs, there are some ways to do it, but you must be careful to do it right to avoid any penalties. Here are some possibilities.
Continue Working
One way to avoid taking RMDs is to keep working past retirement age. As long as you continue working for an employer for the entire year, you are not required to take RMDs. This exception is invalid if you own more than a five-percent share of the company stock.Forbes says that the limitation that allows waiting on withdrawing RMDs is that it only applies to retirement accounts you have with your current employer. Once you stop working, even if only part-time, you must start taking RMDs by April 1 of the following year. You will have to take RMDs from retirement plans you have with previous employers when you reach your RMD age.
Make a Roth Conversion
Money in a retirement savings account that requires an RMD can be rolled over into a Roth account. You must pay taxes on any money you put into a Roth IRA or a Roth 401(k). Because of the taxes, you will probably want to make smaller contributions over several years.After you make the Roth conversion, you will not pay any taxes on your withdrawals from that account or on the growth. Required minimum distributions are not mandatory from these accounts, enabling you to let the money grow if you do not need it. Roth accounts require that the money stay in the account for five years before you can make a tax-free and penalty-free withdrawal.
Donate to a Qualified Charitable Distribution
If you have an IRA, you can make a direct qualified charitable distribution (QCD) to a qualified charity and get a tax deduction for the entire amount. If you are 70½ or older, you can donate up to $105,000 in 2024 or a lesser amount to satisfy the RMD requirement.When you make a donation, the money donated will count towards your RMD, or it may be for the entire RMD. Investopedia says you cannot make direct donations from a 401(k), but you can roll the money over to an IRA and then make the donation.
Reduce the Size of the Account Before Retirement
Retirement accounts can grow to millions of dollars if you started making contributions when you were young. Accounts of this size can put your income into a higher tax bracket when you withdraw an RMD. Instead of waiting until you retire, you can start making withdrawals anytime after you reach 59½.
Withdraw enough money each year so that, when you retire, your RMDs and taxes will be smaller. If you do not need the money, reinvest, or put it into a Roth account. If you can, divert some of your contributions into a Roth account early to prevent high taxes later. When you make this conversion, you will pay taxes on the money, but there are no RMDs with a Roth account.
Being in a higher tax bracket can subject you to Medicare’s surcharges. Kiplinger says that withdrawals from a Roth account are shielded from Medicare because they do not get added to your adjusted gross income. Remember that Medicare looks back two years to make their decisions on surcharges.
Another advantage of this strategy, Schwab says, is that if you can live off the money from your early withdrawals until you turn 70, you can claim the maximum Social Security benefits. The benefits grow 8 percent every year.
Contribute to an Annuity
Another way to delay RMDs is to purchase a qualified longevity annuity contract (QLAC). SmartAsset says you can use money from a 401(k) or IRA to contribute, which will count toward your required minimum distribution. You can make contributions of up to $135,000 annually. It is not necessary to start collecting the money until you are 85.Inherited Retirement Accounts
People who inherit a retirement account need to follow different rules. Before the SECURE 2.0 Act, beneficiaries receiving an inherited retirement plan could take their remaining lifetime to withdraw the money. After the Act, beneficiaries must withdraw the entire amount within 10 years.Talking to a financial advisor before deciding how to lower your RMD taxes or delay taking them will enable you to make the best choices. They are the experts on the subject and every case is different.
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