Many people love saving for retirement in traditional IRAs or 401(k)s because of the up-front tax break. Shielding some of your income from the IRS could result in lots of tax savings from year to year.
The downside of having a traditional retirement account is having to worry about required minimum distributions, or RMDs. Those could create a huge tax headache for you in retirement if you don't need the money. But if you blow off your RMDs, you could risk a 25% penalty on the sum you fail to remove.
Image source: Getty Images.
The good news is that there may be a way to avoid RMDs this year. But it's important to know the rules.
Working could let you off the hook
If you're 73 or older this year, it means you're supposed to be taking RMDs from any traditional retirement plan you have. But if you're still working, you can get out of taking an RMD from your current employer's retirement plan, provided you don't own 5% or more of the company.
This rule applies whether you work full-time or a few days a week. As long as you're on the payroll as an employee, you don't have to take an RMD from your current employer's retirement plan.
However, this exception only applies to the retirement plan offered by your current employer. It may be that you have money in your current employer's 401(k), but the bulk of your retirement savings is in a separate IRA.
In that case, you're exempt from taking an RMD this year from your workplace plan. But you still have to take your RMD from your IRA. Failing to do so could mean getting penalized.
Make the best of your RMDs
If you can't get out of your RMDs completely this year, it's important to try to make the most of that money. If you're worried about a big tax bill, donating your RMD directly to charity could wipe out that IRS obligation.
If you don't want to give the money away to charity, which is understandable since it's yours, think about the different ways it could enhance your life. Your RMD could be your ticket to taking your grown kids and grandkids on a dream vacation, or to renting a large home for an extended family reunion. It could help you fund a renovation that makes your home more comfortable or treat yourself to new furniture.
It's not a given that you'll have to take an RMD this year, even if you're 73 or older. But make sure you understand how RMD exceptions work so you don't end up making a mistake that costs you. And if you can't ditch your RMDs completely, think about ways to use that money well.
