Lower Your RMD Tax Burden With These Tips

There are several ways to minimize your RMD tax burden. Hadayeva Sviatlana/Shutterstock

If you have pre-tax retirement accounts, you'll eventually need to take required minimum distributions (RMDs). RMDs must begin when you reach a certain age (currently 73 or 75, depending on your birth year) and continue annually until your account is depleted or you pass away.

Because contributions to the retirement account were not taxed, you now owe taxes. If the RMD is big enough, it may force you into a higher income tax bracket. This means a higher tax liability. There are, however, some ways to diminish an RMD’s impact.

At What Age Do You Take RMDs?

The Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 changed the eligibility age for taking RMDs. According to Thrivent, the new ages are:

• 72 if you were born in 1950 or earlier
• 73 if you were born between 1951 and 1959
• 75 if you were born in 1960 or later

However, you can take voluntary distributions at age 59 1/2.

How Are RMDs Taxed?

Your RMDs will be taxed as ordinary income in the year you take them. If you have a lower income, this may not be a problem. But if you are already in a high-income tax bracket or fear you’ll be pushed to a higher one, there are some opportunities to eliminate or defer your tax liability.

Shrink Your Money for RMDs

You can shrink the money in your tax-deferred accounts before you have an RMD. You can do this by converting your tax-deferred dollars to a Roth. You must be at least 59 1/2 and have had the Roth for at least five years. But once rolled into the Roth, it can grow tax-free. Don’t do this before age 59 1/2 or you’ll incur an additional 10 percent early withdrawal tax, according to the IRS.

Of course, you’ll need to pay the 20 percent tax when you withdraw it from the tax-deferred account. But it won’t be growing in a taxable account. Instead, it will grow in a nontaxable account that doesn’t require RMDs.

Deferring RMDs When Working

If you are still working beyond age 72 and don’t own 5 percent or more of the company you work for, you can delay taking RMDs. This only applies to your current employers’ 401(k) or 401(b) plans. If you have any former employer plans or a traditional IRA, you still must take an RMD.

There is a workaround to this rule. If your employer allows the former plan to be rolled into the current plan, you won’t need to take an RMD until you retire. However, you’ll still need to take RMDs from any traditional IRA.

Younger Spouse Rule

When calculating an RMD, divide your year-end account balance from the previous year by the IRS life expectancy factor. This can be found in the IRS’s Publication 590-B. This is based on your birthday in the current year. An RMD must be calculated for each account you own. You’ll need to take each RMD separately.

Most original account owners use the standard RMD calculation. But if you’re the original owner with a younger spouse and they are the sole beneficiary, you can trim your RMDs.

According to the IRS, you must be married to someone at least 10 years younger than you to do this. The calculation lets you divide your year-end account balance by the IRS life-expectancy factor at the intersection of your age and your spouse’s age.

There is also an application for the younger spouse rule if the surviving spouse is at least 10 years younger than the decedent. This is also found in the IRS’s Publication 590-B.

Qualified Charitable Distribution

Consider a qualified charitable distribution (QCD). According to the IRS, the QCD rule allows IRA owners aged 70 1/2 and older to transfer up to $100,000 directly to a charity. It can count as all or a portion of your RMD.

This is smart if you were planning to donate to a charity and you take the standard deduction rather than itemizing deductions, including charitable donations.

But the money must go directly to a charity. It can’t go to you and then to a charity, or it won’t count as a QCD, and you will be taxed.

Transfer Shares to Brokerage Account

An RMD doesn’t have to be cash. You can have your IRA custodian transfer shares to a taxable brokerage account. For example, you could transfer $5,000 worth of shares to satisfy an RMD of $5,000. You just want to ensure that the amounts match. The transfer date serves as the share’s cost basis in the taxable account. One advantage to doing this is that if the investment falls in value while in the taxable account, you could harvest a tax loss.

Plan to Manage RMD Taxes

There are several ways to minimize your RMD tax burden, but it does take some planning. For example, you may want to start planning in your early 60s. Consider discussing your RMDs with a qualified tax adviser or wealth manager.

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