If you’ve been diligently saving for retirement in a tax-advantaged account like a traditional IRA or 401(k), there’s a point where the IRS wants its cut. That moment comes in the form of Required Minimum Distributions (RMDs). You must begin taking these mandatory annual withdrawals once you reach a certain age. This guide breaks down what RMDs are, how they're calculated, how they’re taxed, and how to reduce the taxes you pay on them through smart planning.
Also check out, these 10 mistakes that could ruin your golden years.
Read More:
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- Here's what you need to know before claiming Social Security benefits.
What are RMDs?
Required minimum distributions are the amount you must withdraw per year from your tax-advantaged retirement accounts once you reach 73 years old (75 for those born after 1960). This applies to traditional IRAs, 401(k)s, 403(b)s, SEP IRAs, SIMPLE IRAs, 457 plans, and inherited Roth IRAs. For workplace savings accounts, such as 401(k), you can delay your RMDs if you are still working. You can delay them until April 1st of the year after you retire.
For IRAs inherited from someone other than your spouse after 2020, you must withdraw the balance within 10 years.
How are RMDs Calculated
Required minimum distributions are calculated by using the account balance from the previous year and your life expectancy factor. Your life expectancy factor is calculated by the IRS using the Uniform Lifetime Table. Your RMD for the year is the account balance divided by your life expectancy factor.
For example, if your account balance on December 31, 2024, was $500,000 and you were 65 and single, your Life Expectancy Factor is 22.9. So, $500,000 divided by 22.9 is $21,834. This is the amount you would have to withdraw in 2025.
How are RMDs taxed
If the contributions were tax-deductible when made, then RMDs are taxed as ordinary income. If the contributions were non-deductible, then only the growth is taxed as ordinary income.
Reduce Taxes by: Beginning Withdrawals Early
If you have oversaved in a tax-advantaged account, then your RMDs could be quite large and therefore push you into a higher tax bracket. If you start strategic withdrawals earlier, you can begin to reduce the balance in your account and make your RMDs smaller when the time comes.
This additional income can also help delay Social Security, which will make your monthly Social Security payments larger.
Reduce Taxes by: Converting to a Roth IRA
Roth IRAs are exempt from RMDs. Converting accounts that have contributions that have tax-deductible contributions in to a Roth will cause them to be taxed as income at the time of the conversion. But if you do this slowly over time, you may end up paying less taxes than you would have if you did RMDs.
Reduce Taxes by: Investing RMDs in a Taxable Brokerage Account
Even though you must withdraw your RMDs, you don’t have to spend them immediately. If you don’t need the funds for living expenses, you can reinvest them into a taxable brokerage account, using tax-efficient investments such as index funds or municipal bonds. This helps your money continue to grow while minimizing the tax drag on future earnings. The key is selecting investments that generate little taxable income to keep your annual tax bill lower.
Reduce Taxes by: Donating to Charity
If you itemize, you can deduct your charitable donations. Donating your RMDs to charity will remove any additional tax burden they would have otherwise caused. If you are over 70.5 years old, you can donate up to $100,000 directly to charity from your IRA and avoid income taxes, even if you don't itemize.
If you aren't 70.5 years old yet, consider a donor-advised fund to handle your charitable contributions.
Reduce Taxes by: Using Your Younger Spouse to Reduce RMDs
If your spouse is 10 years younger than you, then you can use a different life expectancy table, which will reduce your RMDs. For example, if you are 65 and single, your Life Expectancy Factor is 22.9. However, if your spouse is 55 years younger than you, your Life Expectancy Factor is 33.9.
If your account balance is $500,000, your RMDs would drop from $21,834 to $14,749.
Reduce Taxes by: Delaying Social Security
Depending on your income, your Social Security payments could be taxable. Since RMDs are considered income, they could push you over the income thresholds for Social Security taxes. If you take larger payments earlier in your retirement, this will reduce your balance for RMD calculations later. Delaying Social Security payments also increases the monthly amount you'll receive from Social Security when you start taking it.
Keep in mind that choosing whether or not to delay taking Social Security is a big decision that has many factors.
Reduce Taxes by: Continuing to Work
Money in a workplace retirement plan is exempt from RMDs while you are still working. This method is just kicking the can down the road, since RMDs will begin April 1st after you stop working. But if you want to avoid RMDs for now, this is an option.
Reduce Taxes by: Gifting Money to Beneficiaries
While this won't reduce your income taxes, it may reduce estate taxes after you die. The strategy is to take your RMD like normal and pay your taxes accordingly. You can then gift the funds to your children or other beneficiaries, thereby reducing your overall estate. When you pass away, your family will owe less in estate taxes.
- Also check out, these 10 mistakes that could ruin your golden years.
