There are almost 75 million Baby Boomers—those born between 1946 and 1964—in the U.S. today. Approximately 10,000 of them retire each day. That's a lot of potential people taking required minimum distributions (RMDs) who may not need them, missing a big opportunity in their financial plan.
Let's start with the basics: how is an RMD amount calculated? Your RMD amount is calculated based on your age (converted to a life expectancy factor) and the account balance of your IRA as of 12/31 of the prior year.
Understanding this baseline will illuminate why some of the strategies below work to reduce your RMD, allowing you to more freely decide when to make a withdrawal and recognize income (pay tax).
The other important thing to know: once you reach age 72 and it’s time for your first RMD, you must begin taking withdrawals from your traditional IRAs and 401(k)s each year—whether you need it or not. The funds distributed are treated as ordinary income, meaning they could boost you into a higher tax bracket if you don't strategically plan ahead.
While you may not need to use those RMDs for living expenses if you have other income, failing to distribute the correct amount could sack you with a big tax penalty worth up to 50% of the amount you should have taken.
Fortunately, there are several tax-efficient moves you can make to avoid penalties and minimize liability. If you don't necessarily need the money from your RMD, but you don't want to leave the IRS a tip, consider the following seven strategies:
Consider A Charitable Contribution
When you direct your RMD to a charity, it becomes a qualified charitable distribution, or QCD, which is no longer considered taxable income.
IRA account owners who are at least 72 may transfer as much as $110,000 directly to charity each year, tax-free. This is an especially good use of your RMD if you take the standard deduction and wouldn't be able to write off charitable donations but still have causes you'd like to support.
A QCD also provides a higher dollar for dollar tax benefit compared to a donation of cash or appreciated securities from someone who can itemize because it directly reduces adjusted gross income (AGI).
Convert to a Roth IRA: Roth Conversions
If you're reading this article learning about RMD alternatives, you likely have a traditional IRA or 401(k). If you also have Roth accounts such as a Roth 401(k) or Roth IRA, consider rolling money over into the Roth IRA (which has no RMD requirements for the original account holder) through what is known as a Roth conversion.
Keep in mind that you'll still have to pay taxes on the rollover amount, but this is a long-term tax minimization strategy.
If you’re already 72, you’re still required to take your RMD before converting, but it can still be helpful because converting doesn’t need to be done all at once. You can roll a portion each year to manage the tax liability, which will also reduce the RMD in the future.
Here's a bonus tip: The age you must start taking an RMD is different for 401(k)s compared to IRAs. The IRA RMD age is set at 72 or 73 depending on the year you were born, whether or not you are still working. However, with 401(k)s, RMDs don't kick in until you retire (with an exception for larger owners).
Because of this, if you're still working and not greater than a five percent owner of the company, you could also roll funds from IRA into a 401(k), potentially delaying when you would need to recognize that income to a more strategic time.
Reduce Your Taxed Amount
If you have company stock in your 401(k), consider rolling the non-stock portion of it into a traditional IRA and transferring your employer stock to a taxable brokerage account. That way, ordinary income tax will be due on the stock’s cost basis, not its market value.
Of course, any unrealized appreciation is taxed as long-term capital gain when the position is sold, but going forward, you'll still have RMDs on the balances in the traditional IRA, but at a much lower level without your company stock in the account.
"Lengthen" Your Life Expectancy
(Not so) fun fact: your RMD is partially calculated based on how long the IRS expects you to live. If your spouse is more than ten years younger than you, their longer life expectancy can be used to reduce your RMD.
You can refer to Table II of IRS Publication 590-B to calculate the subsequent impact on your taxes, but long story short, the RMD system partially exists to ensure saved income is at least partially recognized (and therefore taxed) while you're alive.
If you're 76, for example, and married to a 62-year-old and your IRA was worth $650,000 at the end of the previous year, your RMD would drop more than 6% percent to about $25,793 the next year.
Account For Your Nondeductible Contributions
Any nondeductible contributions made to your traditional IRA are not subject to further taxation when removed from your qualified retirement account.
Keep records of these amounts to figure out the ratio of your nondeductible contributions to your entire IRA balance. That way, you can reduce the tax bill on your RMD.
Transfer to a Different Account
Up to this point we've covered many ways to divert or reduce your required minimum distribution, but once those options are exhausted, if you still don't technically need those funds, you can shift your focus toward recognizing the income, but then putting it to work for your plan.
For example, RMDs do not have to be made in cash, so you can direct your custodian to transfer shares to your taxable brokerage account instead.
While the distribution will still be taxed, any further appreciation in the asset will be subject to capital gain taxes when sold, which are charged at a lower rate than ordinary income taxes.
Invest For Growth
Consider redirecting your distributions into investments that generate minimal to no additional taxable income. If you do this, your RMDs will work for you without much effort on your part. And the appreciation could potentially offset the taxes you paid on the RMD.
Don't Forget Social Security
If you're planning to handle your financial plan on your own, don't forget to factor in how social security will impact your retirement income. Retirees can too easily make the mistake of planning an RMD withdrawal strategy that doesn't include social security, bumping their tax bracket unnecessarily.
Next Steps
When it comes to RMDs, it can literally pay to know the rules. If you think a retirement plan is a 'set it and forget it' situation, you're probably missing out. The reality is the rules change over time, and it can be difficult to keep up but the penalties can be steep, especially for those who have saved seven figures and above.
Retirement is a time for relaxation, not financial stress. Make sure you spend time planning with your financial advisor or wealth manager to maximize your retirement savings—and then enjoy the fruits of your labor.
Don’t have a trusted advisor on your side? Download our free guide to wealth management to see if a partnership may be right for you.
