Always use the rules to your advantage. This makes sense when playing sports and running a business. And it definitely makes sense for retirees in managing their finances.
The Internal Revenue Service (IRA) has a lot of rules related to required minimum distributions (RMDs) from tax-deferred retirement accounts. Can retirees use those rules to their advantage? Absolutely. Here are five smart strategies for taking RMDs.
Image source: Getty Images.
1. Time when you begin withdrawals strategically
You must take your first RMD by April 1 of the year after you turn 73. Some retirees might think it's best to wait as long as possible to take the distribution. However, that might not be the best approach.
Let's assume you turn 73 in October. You could wait until early in the next year to take your first RMD. The problem with doing this, though, is that you must take your second RMD by the end of that same year. Two withdrawals in the same calendar year could bump you into a higher tax bracket.
Time when you begin taking RMDs strategically. Withdrawing in the same year you turn 73 could result in you paying lower taxes.
2. Automate your withdrawals
The penalty for not taking an RMD by the due date is 25%. You might think that's a steep price to pay, but it used to be 50% before the SECURE 2.0 Act went into effect. The penalty can be reduced to 10% if you correct the issue within two years. However, it's still costly to miss taking an RMD on time.
One way to avoid this problem is to automate your withdrawals. Check to see if your online brokerage allows you to set up a scheduled RMD. Several top brokers offer the capability, including Fidelity Investments, Bank of America's Merrill Lynch, Charles Schwab, and Vanguard. Taking advantage of automated RMDs could prevent you from making an expensive mistake down the road.
3. Consider using Qualified Charitable Distributions (QCDs)
Do you have a favorite charity or perhaps regularly donate to your church, mosque, or synagogue? Consider using qualified charitable distributions (QCDs), which allow you to transfer up to $100,000 tax-free each year from an individual retirement account (IRA) directly to a charity.
You'll need to contact your IRA trustee to initiate a QCD. Note that QCDs are only available with IRAs and not 401(k) plans. However, you could roll over money from a 401(k) to an IRA and then use a QCS to make a tax-free donation to charity.
4. Consider taking RMDs in kind
What if your retirement account is invested in assets whose prices have fallen significantly but you think will rebound over time? You might want to consider taking RMDs in kind. This means you'll transfer securities from your retirement account to a taxable brokerage account.
The main advantage of this approach is that you maintain your exposure to the depressed security without taking a big loss but still meet the RMD obligation. You could even eventually lower the amount of taxes paid. If the security rebounds and you sell it from your taxable account, you'll pay taxes at the capital gains rate, which is typically lower than ordinary income tax rates.
5. Use tax-loss harvesting
This final strategy doesn't involve taking your RMD. Instead, it can help you lower your taxes after taking your RMD. Tax-loss harvesting is an approach in which you sell investments with unrealized losses. You then apply those losses against capital gains that have been previously realized to lower your taxes owed.
For example, let's assume you bought a stock five years ago for $5,000 and sell it this year for $10,000. You'll have a capital gain of $5,000. Now, let's suppose you also have a stock you bought five years ago for $10,000 that has declined in value by 50%. You can sell it at a loss of $5,000 and use that loss to offset your capital gain.
Note that tax-loss harvesting only works in taxable brokerage accounts. You also must have positive capital gains against which to apply your losses.
