Saving for retirement in a traditional IRA or 401(k), as opposed to a Roth, can seem like a good idea when you're eager to lower your tax bill. But traditional retirement plans come with a huge drawback. Not only are withdrawals subject to taxes, but you may eventually have to take withdrawals even if you don't want to.
Those mandatory withdrawals are known as required minimum distributions, or RMDs. And they kick in at age 73 or 75, depending on the year you were born.
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RMDs can cause you a host of problems in retirement. Not only can they push you into a higher tax bracket, but they could also drive up the cost of your Medicare premiums by leaving you subject to surcharges known as IMRAAs, or income-related monthly adjustment amounts.
The good news? There's a step you can take to reduce your RMDs in retirement. But you'll need to plan ahead to pull it off.
Pre-RMD withdrawals are a good solution
Roth conversions are a good option for getting out of RMDs or reducing them. But many people wait until the last minute to do a Roth conversion and end up moving a large sum of money at once out of a traditional retirement account. That tends to produce a very large tax bill.
Plus, depending on your age, doing a large Roth conversion in a single year could put you at risk of Medicare IRMAAs. So a better bet may be to do your conversions over time.
Another option many people overlook? Rather than do a conversion, simply take withdrawals from your IRA or 401(k) before RMDs begin.
Let's say you have to start taking RMDs at age 73 but you retire at 65. During that eight-year gap, you may have a fairly low income and therefore land in a fairly low tax bracket.
If you withdraw funds from your IRA or 401(k) during that time, you'll have less money subject to RMDs down the line. You can then reinvest the money you're withdrawing so it doesn't go to waste.
If you do those withdrawals during a fairly low-income year, not only might your tax bracket not rise too much, but you may not risk pushing your income into IRMAA territory. So all told, it's a strategy that could spare you a lot of financial pain.
Plan ahead for maximum success
One reason older people run into trouble with RMDs is that they wake up at the last minute and realize they're a year or two away from potentially large mandatory withdrawals. A better bet? Plan early.
Work with a financial professional to map out the timing of Roth conversions or traditional retirement plan withdrawals to maximize lower-income years. It could spare you a lot of financial stress (and massive taxes) down the line.
