Must Know Retirement Tax Strategy

Do you have a retirement tax strategy that helps you keep more of your hard earned money in retirement? After attending two local retirement tax strategy seminars, I learned the importance of planning in advance. The process requires understanding how much you plan to spend in retirement each year; your retirement budget. Also, we’ll need to know how we’ll access the funds to pay the least amount of taxes, legally of course.

It is said that 70% of Americans feel they have inadequate retirement plans, according to a 2018 study by Northwestern Mutual. How do we fix that issue? Learn the basics associated with retirement tax planning. Below is what I’ve learned in the past few months about RMDs and taxes.

Retirement Tax Strategy

Required Minimum Distributions (RMD): Once you reach age 70 1/2, you are required to annually withdrawal a certain percentage of your nest egg from your tax-advantaged retirement accounts. Typically, these accounts include: your traditional IRA, 401(k), SEP, Solo 401(k), and so on. Once you determine how much you need to withdrawal each year, you must calculate and pay tax on the distributions. Clearly, to optimize my income in retirement I needed to get up to speed on the RMD requirements. Otherwise, I might not be able to execute a retirement tax strategy that helps me keep more of my nest egg once I retire.

Now that I understand the basic RMD rules, I’m making adjustments to my pre-retirement financial plan. I am updating my Retirement Financial Planner Spreadsheet for sure.

Assuming we don’t inherit an IRA or have some special situation, we are subject to RMDs when we reach age 70½. And, the distribution is taxed as ordinary income. It is my understanding that you must take your first RMD by April 1 of the year after you turn 70½. The second and all subsequent RMDs must be taken by December 31. Note an account owner who delays the first RMD would need to take two distributions in one year. For example, a taxpayer who turns 70½ in February 2019 has until April 1, 2020, to take his first RMD. But he or she must also take his or her second RMD by December 31, 2020.

So, it appears I need to look at my expected tax rate under two scenarios: taking my first RMD in the year I reach 70½, and a second scenario where I delay taking the first RMD until the following year. The latter would double up my RMD while delaying the distribution and tax payment. As long as doubling up my RMDs doesn’t push me into a higher tax bracket, that may be the best retirement tax strategy to lower taxes. In addition, I’ll need to consider whether this strategy will result in higher income-related Medicare premiums according to what I’ve learned so far.

Calculate RMD: There are several online RMD calculators available from the brokerage firms including Charles Schwab’s RMD Calculator. Google RMD calculator for others. Estimate your RMDs based on your expected account value when you retire. Note if you own multiple IRAs, you need to calculate the RMD for each account.

There are also other rules for taking your RMD. For instance, you can take the total RMD from just one IRA or any combination of IRAs. However, that’s not the case for me given my wife and I own multiple 401(k)s. Unlike IRAs, owning multiple 401(k)s will require us to calculate and take each 401(k) RMD separately. In addition, our Roth 401(k) is also subject to RMDs from that account at age 70½, although the distributions from this account will be tax-free.

I understand we can take our annual RMD in a lump sum or in periodic payments (monthly, quarterly, etc.); anytime up to the deadline. The longer we can delay taking our RMD within the required deadline period, the longer our money can grow tax-deferred in our account(s). In other words, it appears waiting as long as we can within the year to take our RMDs is best with respect to retirement tax strategy basics.

However, you definitely DON’T want to miss the deadline! Why? Severe penalties such as 50% of the shortfall. I learned it is going to be prudent to setup automatic payment of RMDs to avoid missing the RMD deadline.

There are several other retirement tax strategy recommendations I’ve encountered while learning the basics, such as:

Work Waiver – still working beyond age 70½ and don’t own 5% or more of the company? According to an article I read on Kiplinger (see Additional Resources below), you can avoid taking RMDs from your current employer’s 401(k) until you retire. But, you must still take RMDs from old 401(k)s you own and from your traditional IRAs also according to the article.
Roll the money into a Roth IRA (no RMDs for the original owner) – Assuming you are 59½ or older and have owned at least one Roth IRA for at least five years, the money rolled to the Roth IRA can be taken out tax-free.
Charitable Contributions – one presenter at the seminar I attended mentioned using a qualified charitable distribution, or QCD. It is a retirement tax strategy for those that give to charity regularly. It allows IRA owners age 70½ or older to transfer up to $100,000 directly to charity each year. The QCD can count as some or all of the owner’s RMD, and I understand the QCD amount doesn’t count as adjusted gross income.
Convert traditional IRA money to a Roth IRA – you will owe tax on the conversion at your ordinary income tax rate. But, it may work out to lower your traditional IRA balance to reduce future RMDs. Roth conversions are considered a hedge against future tax increases. I also learned traditional IRA distributions count when calculating tax. It can be important for Social Security benefits and Medicare premium surcharges for high-income taxpayers. Roth IRA distributions do not count. In an emergency or a situation where you need extra income, drawing from your Roth won’t increase your taxable income.

In summary, retirement tax strategy requires a bit of planning and basic financial education. I find it somewhat complicated, but spending the time to attend a few local financial seminars and reading a few articles definitely helped tremendously. I hope what I’ve learned and posted here helps you as well.

Additional RMD Resources