If you have a traditional (non-Roth) IRA or employer-sponsored retirement plan (such as a 401k), you’re probably aware that you must take required minimum distributions (RMDs) beginning at age 72 (70½ if you reached that age before 2020). Note: To provide some financial relief during the COVID-19 pandemic, the CARES Act suspended RMDs for 2020 only. If you reached age 72 this year or will turn 72 by the end of the year, it’s a good idea to consider strategies for minimizing the impact of RMDs. One thing you can’t afford to do is miss an RMD: The penalty is 50 percent of the amount you were required withdraw.
Generally speaking, unless you need the funds to live on, it’s best to keep funds in your tax-advantaged retirement accounts as long as possible to maximize the benefits of tax-deferred earnings and to avoid increasing your tax liability this year. Here are a few strategies to consider:
- If you’re charitably inclined, consider a qualified charitable distribution (QCD). Taxpayers aged 70½ or older are permitted to transfer up to $100,000 per year tax-free directly from your traditional IRA to a qualified charity and count that amount toward your RMD for the year. This strategy allows you to satisfy your RMD obligation without increasing your taxable income, while sidestepping charitable deduction limitations that would apply were you to donate other assets. Keep in mind that QCDs are only available for traditional IRAs, not employer-sponsored retirement plans, but it may be possible to roll funds over from an employer plan to an IRA and use the IRA to make a QCD.
- Keep working. It may be possible to postpone RMDs from an employer-sponsored plan until you stop working. This option is available only if your current employer’s plan allows it (you can’t defer RMDs from previous employers’ plans or from IRAs). It’s also unavailable if you own more than 5 percent of the company.
- Name your younger spouse as sole beneficiary. Ordinarily, to calculate the amount of your RMD, you take your account balance as of the end of the previous year and divide it by your life expectancy pursuant to IRS tables. However, if your spouse is more than 10 years younger than you, and you name him or her as your sole beneficiary, you’re permitted to use your joint life expectancies, significantly reducing the amount of your RMDs.
- Use retirement funds to purchase a qualified longevity annuity contract (QLAC). A QLAC can be funded with up to 25 percent of your retirement account balance (but not more than $135,000). This allows you to avoid RMDs on those funds until age 85, when the annuity payments begin.
Although it’s usually best to defer RMDs, there’s one potential exception to this rule. In the year of your 72nd birthday, you have until April 1 of the following year to take your first RMD. So, for example, if you turn 72 in 2022, you’ll have until April 1, 2023, to make your first withdrawal. But it’s important to evaluate the potential impact on your 2023 tax liability. If doubling up on RMDs next year would push you into a higher tax bracket, you may be better off taking your first RMD this year.