For most retirees, required minimum distributions (RMD) from retirement accounts are needed to cover daily expenses of living. For some retirees however, RMDs reflect taxable income they don’t need. In their case, while saving for retirement worked too well, the IRS intends to collect on its part of the bargain that let you defer taxes while building and growing your retirement assets. If you don’t need these income streams, you have a few options to consider. One allows you to skip taxes altogether, while the others seek to manage taxes as efficiently as possible.
Make a gift to charity
RMDs can be directed to qualified charities in whole or in part. Unlike traditional charitable contributions which reduce taxable income, using your RMD for a charitable gift reduces your Adjusted Gross Income (AGI). Reducing AGI can better help mitigate taxes on net investment income or the ‘means tested’ portion of Medicare premiums. Gifts must be paid directly to the charitable organization by the IRA custodian and there is an annual limit of $100,000.
Consider rolling a portion of your IRA balance over to a Roth IRA. You will still owe taxes on the amount being rolled over, but you have gained three benefits. One, your IRA balance is now lower and so too will be your subsequent RMDs. Two, there are no RMDs from Roth IRAs. Three, following your death, any distributions taken by your spouse or other beneficiaries will most likely be tax free. Conversions can be made at any time, but if you are currently subject to RMDs, they must be taken before any conversion.
Beat the IRS to the punch by spreading out your distributions over a longer period of time. This would mean taking distributions earlier than required; you can start withdrawing penalty-free from your IRA at age 59.5. This could serve to supplement and level out your income in a consistent tax bracket and delay having to take a smaller social security payment at an earlier age.
Reinvest for growth
If you don’t need your RMD to cover the costs of your lifestyle, consider reinvesting the income into investments that generate minimal or no additional taxable income. With a long enough time horizon, perhaps into the next generation, the appreciation could more than offset any taxes paid.
Apply carve outs
If your 401k holds company stock, you could take advantage of something called net unrealized appreciation. When you roll all the assets out of your 401k to a traditional IRA, you can carve off the company stock and move it to a taxable account, paying ordinary income tax on the cost basis. You will still have RMDs from the traditional IRA, but they will be lower since you removed the company stock from the mix. Further, any gains from selling the stock now qualifies for the lower long-term capital gains tax rates.
*Disclosure: This is for informational purposes only. Please consult your tax advisor for more details on items mentioned above.