Are you one of the millions of Americans who have used an IRA to accumulate retirement assets? According to a 2013 study, Americans hold nearly $2.5 trillion worth of assets inside IRA accounts.1 Much of those assets are held in traditional IRAs.
Traditional IRAs, 401(k) plans and similar qualified accounts are popular savings tools because they benefit from favorable tax treatment. You often get a current tax benefit for your contributions. Your 401(k) contributions are taken out of your paycheck pretax. That reduces your taxable income. Similarly, you may be able to take tax deductions for your traditional IRA contributions.
Qualified retirement accounts are also tax-deferred. This means you don’t pay taxes on growth as long as the funds stay inside the account. Tax deferral could help you grow your funds faster than you would in a similar taxable account.
Your qualified retirement accounts can’t go untaxed forever, though. The IRS requires you to take taxable distributions from these accounts starting at age 70½. The amount of your required minimum distribution (RMD) is based on your age and your end-of-year account balance. Generally, your withdrawal increases as a proportion of your account balance as you age.
If you don’t plan accordingly, your RMDs could increase your tax exposure. The good news is there are steps you can take to minimize your tax burden. Below are three strategies to consider as you plan for your RMDs:
Convert your IRA to a Roth.
Not all qualified accounts are subject to RMDs. The Roth IRA is a notable exception. Roth distributions are tax-free after age 59½. Since the income isn’t taxable, the IRS doesn’t force you to take distributions by a certain age.
If you’ve used a traditional IRA to accumulate much of your retirement assets, you can convert some or all of those funds to a Roth IRA. You have to pay taxes on the converted amount. However, you won’t pay any taxes on growth or distributions once the funds are in the Roth. It could be worth it to pay the taxes today in order to avoid RMDs and taxes in the future.
Donate your RMDs to charity.
Is charitable giving part of your retirement strategy? Do you have a favorite charitable cause? If so, you could meet your RMD requirements, support charity and minimize your tax burden all at the same time.
The IRS allows you to transfer your RMDs directly to a charitable organization. If you do, the distribution isn’t treated as taxable income. However, the distribution must flow directly from your IRA to the charity. If it’s paid to you, the withdrawal will be taxed.
Don’t wait until age 70½ to take withdrawals.
If the whole point is to minimize your tax exposure, it may seem counterintuitive to take distributions before they’re required. However, distributions earlier in retirement could reduce your account balance, which would then reduce the amount you’re required to take via RMDs when you turn 70½.
This could be an especially helpful strategy if you’re trying to keep your income or your tax rate under a certain threshold. A financial professional can help you carefully plan your distributions. If you take out modest withdrawals before you’re required, you may have less in your account at age 70½, which could reduce your RMDs.
Ready to develop your RMD strategy? Let’s talk about it. Contact us today at Grand Canyon Planning Associates. We can help you analyze your needs and create a plan. Let’s connect soon and start the conversation.