Reducing the Impact of Required Minimum Distributions

If you have a traditional (non-Roth) IRA or employer-sponsored retirement plan (such as a 401k), you’re probably aware that you must take required minimum distributions (RMDs) once you reach a certain age. If you’re already receiving RMDs, or will soon be required to take them, it’s a good idea to consider strategies for minimizing their impact. One thing you can’t afford to do is miss an RMD: The penalty is 25 percent of the amount you were required withdraw (with certain exceptions, discussed below).

When do RMDs start?

If you were born:

Your RMD starting age is (or was):

Before July 1, 1949

70½

From July 1, 1949, through December 31, 1950

72

From January 1, 1951, through December 31, 1959

73

On or after January 1, 1960

75

The SECURE 2.0 Act, which took effect in 2023, increased the starting age for RMDs for certain taxpayers, depending on the year their birth dates. Under current rules, the starting ages are as follows:

 This means that if your 72nd birthday is in 2023, your RMD starting age is now 73, so your first RMD won’t be due until April 1, 2025. If you previously scheduled a distribution for late 2023 or early 2024 based on prior law, consider rescheduling it. If you will reach age 73 after 2032, your starting age will go up to 75.

Planning Strategies

Generally speaking, unless you need the funds to live on, it’s best to keep funds in your tax-advantaged retirement accounts as long as possible to maximize the benefits of tax-deferred earnings and to avoid increasing your tax liability. Here are a few strategies to consider:

·         If you’re charitably inclined, consider a qualified charitable distribution (QCD). Taxpayers aged 70½ or older are permitted to transfer up to an inflation-adjusted $100,000 per year tax-free directly from a traditional IRA to a qualified charity and count that amount toward their RMDs for the year. This strategy allows you to satisfy your RMD obligation without increasing your taxable income, while sidestepping charitable deduction limitations that would apply were you to donate other assets. Keep in mind that QCDs are only available for traditional IRAs, not employer-sponsored retirement plans, but it may be possible to roll funds over from an employer plan to an IRA and use the IRA to make a QCD. In addition, under the SECURE 2.0 Act, it’s possible to make a one-time QCD of up to an inflation-adjusted $50,000 to a charitable gift annuity or charitable remainder trust that provides you with an income stream.

·         Keep working. It may be possible to postpone RMDs from an employer-sponsored plan until you stop working. This option is available only if your current employer’s plan allows it (you can’t defer RMDs from previous employers’ plans or from IRAs). It’s also unavailable if you own more than 5 percent of the company.

·         Name your younger spouse as sole beneficiary. Ordinarily, to calculate the amount of your RMD, you take your account balance as of the end of the previous year and divide it by your life expectancy pursuant to IRS tables. However, if your spouse is more than 10 years younger than you, and you name him or her as your sole beneficiary, you’re permitted to use your joint life expectancies, significantly reducing the amount of your RMDs.

·         Use retirement funds to purchase a qualified longevity annuity contract (QLAC). If you’re eligible, you can fund a QLAC with up to an inflation-adjusted $200,000 in qualified retirement savings, allowing you to avoid RMDs on those funds until age 85, when annuity payments begin.

Although it’s usually best to defer RMDs, there’s one potential exception to this rule. In the year you reach the starting age, you have until April 1 of the following year to take your first RMD. So, for example, if you turn 73 in 2024, you’ll have until April 1, 2025, to make your first withdrawal. But it’s important to evaluate the potential impact on your 2025 tax liability. That’s because your second RMD will be due by the end of 2025, and doubling up on RMDs in one year may push you into a higher tax bracket. If that’s the case, you may be better off taking your first RMD in 2024.

Minimizing Penalties

The penalties for missing an RMD are harsh, although thankfully the SECURE 2.0 Act reduced them from 50% to 25% of RMD amounts not withdrawn on time. It’s critical, therefore, to take all RMDs before their deadlines. However, if you do make a mistake and miss a deadline or withdraw too little, be sure to correct the error as soon as possible. Under the SECURE 2.0 Act, the penalty may be reduced to 10% if the missed RMD is “timely corrected” (usually, within two years). In addition, it may be possible to get the penalty waived if you can show that the shortfall in distributions was due to “reasonable error” and that you’re taking “reasonable steps” to remedy it.