The benefit of saving for retirement in a traditional IRA or 401(k), as opposed to a Roth account, is getting a tax break on your contributions. And you have the potential to exempt quite a bit of income from taxes each year, especially if you're able to contribute the maximum to a 401(k).
The problem with traditional retirement plans, though, is that down the line, you're going to be forced to take withdrawals from your account known as required minimum distributions, or RMDs. RMDs kick in at age 73, though that age is 75 for anyone born in 1960 or later. And their purpose is to force savers to spend down much of their nest eggs in their lifetime rather than pass them on as inherited wealth.
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The problem with RMDs, though, is that they have the potential to create a big tax headache for people who don't need the money. And while you could decide to not follow the rules and not take your RMDs, the penalty there is steep -- 25% of the sum you fail to withdraw.
If you have your savings in a traditional retirement plan, you may be resigned to taking RMDs at some point. But you may be worried that your RMDs will cause your savings to run out. The good news, though, is that's not guaranteed to happen by any means.
You're not withdrawing all of your funds
An RMD has you withdrawing a portion of your retirement plan balance each year -- not the entire balance. Now your RMD will change from year to year based on your account balance and life expectancy. But all told, RMDs are not designed to deplete your IRA or 401(k) in short order. They're simply designed to make sure you're tapping your savings regularly.
You're not forced to spend your RMD
All an RMD does is mandate that you remove a certain amount of money from a tax-advantaged retirement plan each year. But there's no rule stating you have to spend that money.
So, let's say your first RMD amounts to $15,000, only between Social Security and other income sources, you don't need any of it. In that case, you could invest that money in a taxable brokerage account, stick it into a savings account, or use it to open a CD -- the choice is yours.
But basically, all the IRS cares about is that the money leaves your retirement account. From there, it's yours to manage accordingly. So if you're worried about running out of savings due to having to take RMDs, make a point not to spend every dollar you withdraw.
Consider housing some savings in a Roth account
It used to be that Roth IRAs were the only tax-advantaged retirement plan to not impose RMDs. The rules recently changed, though, and now, Roth 401(k)s don't require them either. This gives you multiple opportunities to shield some of your retirement income from RMDs if you so choose.
If passing down wealth is important to you, then it definitely pays to consider putting at least a portion of your retirement savings into a Roth plan. However, once again, you can achieve a similar goal with a traditional IRA or 401(k) by simply not spending your RMDs as you take them out. Rather, you can put that money into an account for your beneficiary of choice.
If your tax rate is higher during your working years than you expect it to be in retirement, then a traditional IRA or 401(k) could make the most sense for you, even it means having to take RMDs down the line. If you're careful with the money you're forced to withdraw, you can minimize the risk of ending up with no savings left at some point in time.
