Turning 73 can be considered a key milestone for retirement planning: It’s the year required minimum distributions (RMDs) go into effect for most.
This means you’ll need to start drawing down your balances from tax-deferred retirement accounts like 401(k)s and IRAs.
Since RMDs count as taxable income, they have the potential to trigger significant tax bills. But with thoughtful strategies, you may be able to reduce the RMD tax burden and help preserve more of your hard-earned wealth.
Consulting a financial advisor can be a great first step to factoring RMDs, and the potential tax repercussions, into your retirement plan. A 2023 Northwestern Mutual study found that 66% of U.S. adults admit their financial planning needs improvement. However, only 37% of Americans work with a financial advisor.
5 Ways to Potentially Reduce RMD Taxes After Age 73:
1. Convert Traditional IRA Funds to a Roth IRA
Roth IRAs are not subject to RMDs, making them a potentially powerful tool for reducing your taxable income in retirement.
By converting portions of your traditional IRA to a Roth IRA over time, you may be able to lower the overall balance of accounts subject to RMDs.
For example, at age 73, you might consider converting a portion of your IRA during a year when your other income is limited, such as after completing a major home sale or other large expense.
Keep in mind that Roth conversions are taxable in the year they occur, so it can be important to calculate the potential tax impact ahead of time.
A financial advisor may be able to help with this.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
2. Make Qualified Charitable Distributions (QCDs)
If you’re feeling generous, qualified charitable distributions (QCDs) may help offer a dual benefit: supporting causes you care about while reducing your taxable income.
A QCD allows you to transfer up to $100,000 per year directly from your IRA to a qualified charity.
For example, a 74-year-old who has already fulfilled their personal financial needs might use a QCD to donate part or all of their RMD to a favorite charity, which could help ensure it doesn’t potentially increase their taxable income.
This strategy has the potential to be particularly effective for reducing taxes without increasing your adjusted gross income (AGI), which can impact other tax factors like Medicare premiums.
3. Strategically Withdraw to Manage Future RMDs
For individuals already past 73, strategically withdrawing more from tax-deferred accounts may be able to help manage future RMDs by reducing their size and potential tax impact.
This approach involves taking distributions to stay within lower tax brackets, preventing larger RMDs in later years.
For example, a 74-year-old might withdraw extra funds to cover anticipated expenses or reinvest in a taxable account, maintaining control over their taxable income.
Proactive planning can potentially help you avoid unnecessary tax spikes while meeting your financial needs. A financial advisor could help you determine if this is a smart strategy for you.
4. Adjust Your Investment Allocation
The mix of assets in your retirement accounts has the potential to influence the growth of your balances and impact the size of your RMDs.
Shifting to investments that generate lower returns in tax-deferred accounts and higher returns in taxable or tax-free accounts may help manage the potential growth of RMD-triggering accounts.
For example, a 73-year-old might prioritize holding income-generating bonds in their IRA while keeping growth-focused stocks in their Roth IRA, potentially keeping the traditional IRA from growing to a point that it inflates future RMDs.
Always consider your overall financial goals and risk tolerance before making changes to your portfolio. This is another area where a financial advisor may be able to help.
Asset allocation does not ensure a profit or protect against a loss.
Stock investing includes risks, including fluctuating prices and loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
5. Use RMDs to Pay for Qualified Expenses
At age 73 and beyond, leveraging RMD funds strategically for essential expenses could potentially help reduce the need to dip into other taxable accounts.
For example, you could use RMD funds to pay for qualified medical expenses, home modifications, or even long-term care premiums. If these costs exceed a certain percentage of your AGI, they may also provide potential tax deductions.
This approach could allow your RMDs to be used effectively while potentially offsetting their tax impact.