Saving for retirement in a tax-advantaged account makes a lot of sense. Why not snag some tax benefits in the course of building your nest egg? These benefits might make it easier to fund your long-term savings in the first place.
The problem with this approach could arise later in life in the form of required minimum distributions, or RMDs, which kick in at 75 for those born in 1960 or later. If you were born earlier, you may have to take your first RMD at 73.
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For some people, RMDs aren't an issue. If your RMD for the year is $12,000 but you need $1,000 per month out of your IRA or 401(k) plan to pay your retirement expenses, then it's no big deal -- that's money you were going to remove anyway.
RMDs only become a problem when you don't need the money and don't want to deal with the tax burden they create. But with strategic planning, you can make it so that RMDs don't upend your retirement finances. Here's how.
1. Save in a Roth retirement plan
The simplest way to avoid RMDs is to house your long-term savings in a Roth IRA or 401(k), instead of a traditional IRA or 401(k). While you'll lose the tax break a traditional IRA or 401(k) gives you on your contributions, you'll gain the benefit of keeping your money in your account for as long as you want.
If you're nearing retirement and never saved in a Roth account, it's not too late. You can work with a professional to convert at least a portion of your traditional IRA or 401(k) into a Roth to avoid a tax hassle later on.
2. Amp up your charitable contributions
RMDs during retirement have the potential to increase your tax bill. If you don't need the money you're being forced to remove from your retirement account, donating it to charity could help you avoid taxes on your RMDs.
It pays to set up a qualified charitable distribution (QCD), which has you distributing funds directly from your IRA or 401(k) to a registered charity. The QCD limit for 2024 is $105,000.
3. Plan to invest the money elsewhere
Because steep penalties apply for missing RMDs, it's important to take them when you're supposed to. If you can't donate your RMD to charity or simply don't want to, you may end up paying taxes on that withdrawal. But that doesn't mean you can't put the money to work.
There's no rule saying that the money you remove from your retirement account in RMD form has to be spent. You can invest that money in a non-tax-advantaged account and let it generate returns that pad your savings. You can also take your RMD and use it to invest in tax-friendly assets like municipal bonds.
RMDs can be a pain in retirement but don't have to wreck your senior finances. If you can't avoid them altogether, find ways to manage your mandatory withdrawals as strategically as possible.
