There's a reason so many people are tempted to save for retirement in a traditional IRA or 401(k) plan. The money you contribute to a traditional IRA or 401(k) goes in on a pretax basis, allowing you to shield more of your near-term income from the IRS. That can be helpful if you earn a decent paycheck and are therefore in a higher tax bracket.
But there's a major drawback to having a traditional retirement account. Once you turn 73, you'll be forced to take required minimum distributions, or RMDs (though for workers born in 1960 or later, RMDs don't start until 75).
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Those can be a huge pain for times when you don't have a need for the money. But there may be a lesser-known way to get around RMDs.
The purpose of RMDs
RMDs are mandatory withdrawals that apply to traditional retirement plans like IRAs and 401(k)s. If you have a Roth IRA or Roth 401(k), you won't have to worry about them.
The purpose of RMDs is to effectively get you to spend down your savings in your lifetime rather than use your traditional IRA or 401(k) as a tool to pass wealth down to younger generations.
RMDs are calculated each year based on your account balance and life expectancy. And while you could decide to blow off your RMD, you'll face a 25% penalty on the amount you're supposed to withdraw.
For example, say your RMD is $10,000. If you don't take that withdrawal, you'll lose $2,500 right off the bat. So it pays to remove that money from your IRA or 401(k), even if you don't have a need for it.
The problem, of course, is that taking an RMD automatically triggers a tax bill -- whether you need or want the money or not. That can be annoying, to say the least.
A good way to avoid RMDs is to do a Roth conversion ahead of retirement. But that could result in a huge tax bill, too.
However, there's another way to avoid RMDs. And while this rule won't apply to everyone, it may apply to you.
Continuing to work could get you out of RMDs
While you usually have to start taking RMDs once you turn 73, there's an exception for people who reach that age and are still working. If that's the case, you may be able to get out of them.
However, there are some things to know about this rule. First, you can only avoid RMDs from the retirement plan provided by your current employer.
Let's say you're still working and have $200,000 in your current employer's 401(k), but you also have a $500,000 IRA. In that case, at age 73, you would potentially be exempt from taking an RMD from the 401(k). But you would still have to take one from the IRA or otherwise risk a penalty.
Secondly, you can only avoid RMDs from your current company's retirement plan if you own less than 5% of it. So if you own your business that has a 401(k), you can't necessarily just keep yourself on its payroll at age 73 to avoid RMDs if you're the sole or majority owner.
But if you do qualify to avoid RMDs without a penalty, it could be hugely beneficial. Not only does that allow you to avoid adding to your taxable income, but it also allows your money to continue growing in a tax-advantaged fashion. That's a double win.
Make the most of your RMDs
Not everyone will be able to get out of taking an RMD based on the loophole above. If that's the case, and you have to take your RMD soon, recognize that there's no requirement to actually spend the money.
The only thing RMDs do is force you to remove money from a tax-advantaged retirement plan. You can then take that money and invest it in a taxable brokerage account, start a CD ladder, or buy bonds.
If you don't need the money, you might as well put it to work and let it keep growing. You just may not be able to do so in a tax-advantaged fashion.
