Saving for retirement in a traditional IRA or 401(k) often seems like a great idea. After all, who wouldn't want the benefit of pre-tax contributions?
But that strategy could come back to bite you once you turn 73 or 75. That's when required minimum distributions, or RMDs, begin. And those can be a real pain if you don't actually need the money.
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If you're gearing up for your first RMD, it's important to have a strategy and know what to expect. Here are three important points to keep in mind.
1. Delaying could trigger a larger tax bill
Although RMDs are due by Dec. 31 each year, you're allowed to delay your first one to April 1 of the year after you turn 73 or 75. And that might seem like a smart move, since it means deferring the tax bill that comes with it.
What you may not realize is that delaying your initial RMD could leave you with even more taxes, because you'll then have to take two RMDs the following year. That could push you into a much higher tax bracket, especially if those distributions are substantial. In many situations, spreading withdrawals across two separate tax years is the more tax-efficient strategy.
2. Withdrawals could affect more than your near-term taxes
You may know to gear up for a tax bill on your RMDs. But you may not realize that a large RMD could result in higher Medicare costs two years down the line.
Higher earners are assessed surcharges on Part B and D premiums known as income-related monthly adjustment amounts, or IRMAAs. In some cases, IRMAAs could add hundreds of dollars a month to the cost of Medicare.
You may not be able to do much to avoid IRMAAs if you've reached the point where you have to start taking RMDs and have not done any Roth conversions. But planning for them could help you avoid a cash crunch.
3. You can lower your tax burden by being charitable
If being charitable is something you're interested in, you may be able to avoid taxes on your RMDs. But you have to go about things the right away.
If you take an RMD, deposit the money, and then write a check to a charity, you'll be taxed on your retirement plan withdrawal. If you send that money directly from your IRA to a charity via a qualified charitable distribution, you can satisfy your RMD without being taxed.
If you have savings in a traditional retirement account, RMDs can't be an afterthought. Rather, you have to plan for them carefully. Taking the time to understand different rules and strategies could help you better manage your first RMD, even if you're still unhappy about having to take it.
