If you are taking a required minimum distribution From an IRA, 401(k), or other tax-deferred account and don’t need money to cover living expenses, where should you keep this unnecessary money?
Investors now need to start taking RMDs at age 73 or, if born after 1960, at age 75. Depending on your account balances, this distribution could be a considerable amount of money, perhaps more than you need to live on. One option is to reinvest that money, and a Roth IRA seems like a perfect choice: Withdrawals from Roth accounts are tax-free—including all earnings on your investments—and you’ll never need to take any of those pesky RMDs during your lifetime.
There’s just one catch: You can’t directly convert your RMDs to a Roth. But for some people, there is a potential workaround. For 2024, you can contribute up to $7,000 plus another $1,000 if you’re at least 50 – if you have enough income earned.
Find a financial advisor to discuss your own retirement strategy.
What it is – and isn’t – ‘earned income’
The IRS defines earned income as money you receive for work, such as wages, commissions, bonuses, tips, and fees for speaking, writing, or attending a conference or convention. Income generated from self-employment also counts. Income that does not qualify includes taxable pension payments, interest income, dividends, rental income, alimony, and withdrawals from Roth IRAs or other nontaxable retirement accounts, along with annuities, welfare benefits, unemployment insurance, payments of labor compensation and its Social Security Income.
Another restriction on Roth contributions is the income limit. Once your modified adjusted gross income (MAGI) reaches $146,000 for a single filer or $230,000 for joint filers, your maximum Roth contribution begins to gradually decrease to $161,000 (single filers) or $240,000 (joint filers ). After that, you will no longer be eligible to contribute.
You also need to remember that you need to wait five tax years after your first contribution to any Roth account before you can make withdrawals. Heirs who inherit your Roth will need to withdraw the entire balance within 10 years.
Consider talking to a financial advisor develop a tax-efficient reform strategy.
Other Options in RMDs
If you don’t qualify to make a Roth contribution, you still have options to eliminate, reduce, or delay your RMDs.
Roth Conversion: You can convert your IRA to a Roth account, after taking the RMD for the year. You will pay taxes on the converted amount, so one tactic is to convert the maximum amount available without forcing yourself into a higher tax bracket. Each Roth conversion carries its own five-year rule.
Charitable Contribution: You can use a Qualified Charitable Distribution to donate part or all of your RMD to an IRS-recognized charity and you will not be taxed on the amount donated. To qualify, the money must be transferred directly from your IRA to the charity.
Keep working: Your 401(k) account with your current employer is not subject to RMDs if you are still on the payroll. One tactic is to roll 401(k)s from previous employers into your current plan so they are not subject to RMDs. Once you stop working, however, RMDs will be required.
Be careful: The punishment for not taking an RMD during the required period is heavy – up to 50% of the value of the lost RMD.
A financial advisor can help you navigate the risks and tradeoffs specific to your situation.
Pay attention to all your taxes
Structuring your retirement withdrawals to reduce your tax break It means examining all of your sources of income, including retirement accounts, RMDs, Social Security benefits, pensions, and taxable investment income. For some people, withdrawing money from an IRA early in retirement can reduce the size of their eventual RMDs. If they also delay receiving their Social Security benefits, their value will increase by 8% each year until they reach age 70. Also, be sure to coordinate taxes, withdrawals, and RMDs between spouses, and remember that a younger spouse’s RMDs will not need to be taken until they reach age 73 or 75.
Other common retirement tax measures include investing in tax-exempt bondsmoving to a state without income tax or real estate tax, tax loss harvesting in taxable investment accounts and hold any taxable assets long enough to qualify for lower long-term capital gains tax rates.
To learn more about retirement planning and how to work toward your goals, speak to a financial advisor for free.
Final result
How to manage your RMDs – and all the other tax issues that may arise in retirement – can be complicated. Take the time to estimate your retirement taxes before you start collecting pensions, Social Security, and making withdrawals from retirement accounts.
Tips
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Balancing taxes and retirement income – and figuring out how to minimize taxes in retirement – is a crucial issue. A connoisseur financial advisor can help you decide how to structure and coordinate these payments during your retirement.
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Finding a financial advisor doesn’t have to be difficult. Free SmartAsset Tool matches you with up to three vetted financial advisors serving your area, and you can interview their advisors at no cost to decide which one is right for you.
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Make sure you are protecting your cash reserves inflation, guaranteeing them in an account that generates a competitive interest rate. Leaving money in a low-yield checking account or savings account can stifle your purchasing power over time.
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