If you find saving for retirement complex, imagine the challenge of withdrawing those funds efficiently to keep your tax bill as low as possible.
As high as 70 percent of your hard-won retirement savings could vanish due to income, estate, and state taxes," asserts IRA expert Ed Slott, who authored "Fund Your Future: A Tax-Efficient Saving Strategy for Your Twenties and Thirties" and "The Retirement Savings Time Bomb Tick-Tocks Loudly.
That’s cash that many individuals would rather hold onto personally. Yet, what steps can actually make this possible? Below are nine effective withdrawal methods designed to assist you in sidestepping expensive tax pitfalls and retaining greater portions of your retirement savings.
1. Adhere to the guidelines for Required Minimum Distributions (RMDs)
RMD stands for required minimum distribution , and once you reach the age of 73, you'll be required to begin withdrawing a minimum sum from various retirement accounts like a traditional IRA or 401(k) plans .
You are required to make Required Minimum Distributions (RMDs) every year by April 1 from the year following when you reach age 73, and by December 31 for each year thereafter. To put it another way, if you become 73 in 2024, you must withdraw your initial RMD by April 1, 2025.
As the legislation was enacted, SECURE Act 2.0 In late 2022, the required minimum distribution (RMD) starting age was raised from 72 to 73 in 2023. On January 1, 2033, this age will increase once more to 75.
The consequence of not adhering to the guidelines is significant. Missing the deadline for Required Minimum Distributions (RMDs) incurs a substantial 25 percent excise tax. Should you fail to withdraw your RMD from an account, IRA Correct the error swiftly and resubmit your tax forms—the penalty might be decreased to 10 percent.
If you come up short with your required minimum distribution (RMD), penalties can still be applied. For instance, if your RMD for the year should have been $20,000 but due to an error you only withdrew $5,000, the Internal Revenue Service (IRS) would impose a 25% penalty. This means they could charge you $3,750, which represents one-fourth of the missing $15,000 withdrawal amount.
When calculating your Required Minimum Distribution (RMD), keep in mind that it can vary each year. This fluctuation depends on factors such as your current age, estimated lifespan (a longer expected lifetime means a smaller withdrawal amount), and the total account balance, which should reflect the fair market value of the assets held within your accounts as of December 31st of the previous year prior to taking the distribution.
Take a look at the "Uniform Life Table" in IRS Publication 590-B To assist in determining how much you need to withdraw from your account. financial advisor Can also assist you in making optimal choices when it comes to taking withdrawals from your retirement accounts.
2. Remove funds from accounts in the proper sequence
If your retirement savings are necessary for getting by and you're considering withdrawing funds from an IRA, 401(k), or another account, here’s what you should know. Roth account , resist the urge for immediate satisfaction. While withdrawing from a Roth IRA is tax-free, you could end up losing out due to missed opportunities.
Rather than doing otherwise, opt to withdrawal funds initially from your taxable retirement accounts and proceed accordingly. Roth IRAs by oneself for as much time as feasible.
Doubtful? Think about this scenario: A 73-year-old individual decides to withdraw $18,000 from a conventional IRA and finds themselves in the 24% tax bracket. This means they will end up paying $4,320 in taxes. However, withdrawing the identical sum from a Roth IRA wouldn’t result in any tax payment at all. Now imagine further—should this person avoid Required Minimum Distributions (RMDs) from their Roth IRA and achieve a yearly return of 7%, after ten more years, the total value could reach approximately $35,409. Importantly, these gains remain untaxed upon withdrawal either by them directly or through inheritance by beneficiaries.
3. Understand the process of taking distributions
If you've accumulated multiple retirement accounts due to changing jobs frequently and you're nearing retirement, you'll need to determine how to access these funds. You might not necessarily have to draw from all of them.
Do you have to check all of your accounts? Likely not.
If you have several conventional IRAs, you're able to make withdrawals from each individually. However, a potentially smarter strategy might involve consolidating the assets across all your accounts into a single IRA before making just one withdrawal.
Combining IRAs into one account might streamline documentation, facilitate the calculation of upcoming distributions, and provide more control over your finances. asset allocation , Slott says.
However, you cannot use IRA withdrawals to fulfill your required minimum distribution (RMD) obligations for a 403(b), 401(k), or any other similar plan.
It's important to remember that 401(k) plans cannot be combined to calculate one single required minimum distribution, according to George Jones, a senior tax analyst and managing editor at Wolters Kluwer Tax & Accounting. Consolidating these plans into an IRA can simplify this process.
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4. Grasp the regulations concerning Required Minimum Distributions for spouses
Should you find yourself with a much younger partner likely to inherit your IRA, you might be able to decrease your mandatory withdrawals. This could lead to lower tax liabilities and ensure your retirement savings stretch further over time.
Keep in mind that Required Minimum Distributions (RMDs) are figured out with elements such as your expected lifespan according to the Internal Revenue Service (IRS). However, should you have designated an individual spouse as the exclusive recipient of your Individual Retirement Account (IRA), and this spouse is more than ten years your junior, the calculation for your RMD would be based on a joint-life expectancy chart instead. This adjustment can lessen the sum you must withdraw each year.
For instance, consider an individual retiring at age 73 this year, who must begin taking required minimum distributions (RMDs) by April 1st of the subsequent year. According to the Internal Revenue Service (IRS), such a person has a projected lifespan of 26.5 years from now. If their Individual Retirement Account (IRA) holds $200,000, then their initial RMD for that period would amount to $7,547.17—calculated as $200,000 divided by 26.5.
However, suppose this individual appoints their 56-year-old spouse as the exclusive beneficiary for the retirement account. Then, their combined life expectancy would amount to 31.7 years. Consequently, the initial Required Minimum Distribution (RMD) would be reduced to $6,309. The Internal Revenue Service (IRS) outlines this procedure. A table for this scenario can be found in Publication 590-B. .
5. Donate to charity
Do you have a meaningful cause you wish to contribute to? If one of your long-term financial goals involves supporting a charitable organization, consider utilizing your retirement resources to create an impact.
This legislation permits people who are 70 years old and six months or older to make tax-free contributions, referred to as qualified charitable distributions Up to $100,000 per year can be donated directly from an IRA to a charitable organization as part of the required minimum distribution. This donation does not get counted as taxable income, thus lowering the donor’s potential income tax burden. Additionally, if you submit a joint tax return with your spouse, they too may contribute up to $100,000 yearly under this provision.
However, keep in mind that those making tax-free charitable distributions from their IRAs will not be eligible to claim these contributions as a deductible itemization.
“Either one of these options applies,” explains Slott. “Those who adopt this approach will incur lower tax liabilities; therefore, for those with charitable inclinations, it represents the optimal method for making contributions.”
6. Take "in-kind" withdrawals that count as required minimum distributions (RMDs)
If selling your assets isn't appealing, opting for cash withdrawals might seem simpler, yet it's not mandatory—or necessarily advisable. Instead, consider what are known as in-kind distributions, which involve withdrawing stocks or bonds directly. This approach could be preferable for those aiming to retain their holdings for different purposes. Essentially, these assets would shift from your IRA to a taxable account. On the day of transfer, these in-kind withdrawals will be evaluated based on their current fair market value.
Withdrawing assets directly might be simpler and more cost-effective compared to selling the investments within your IRA and then repurchasing them in another investment account, which could incur additional penalties or charges.
7. Consider delaying RMDs
Delaying your retirement? If you're still employed at 73 and contributing to a 401(k) or 403(b), you might be exempt from Required Minimum Distributions (RMDs)—provided you don't hold more than 5% of the business and your retirement plan allows this exception. Under such circumstances, you can postpone RMDs until April 1 following the year you retire. At that point, you will begin withdrawing funds.
This holds true as long as you're employed at any point during the year. Therefore, if you're 73½ years old and considering retirement before the end of the year, think again unless you wish to take an early distribution. Should you continue working past January 1st—even for just a single day—it will delay your requirement to withdraw the initial RMD by another year.
Remember that the delay applies only to your current employer’s 401(k) plan. However, if you have 401(k) accounts from former employers and you're 73 years old or more, you will be required to withdraw funds from those accounts.
8. Think about doing a Roth conversion
Tax experts and retirement consultants frequently encourage their clients to transfer retirement accounts into Roth IRAs. Roth conversion — where time and tax-free growth can work their magic. However, it isn’t a cure-all solution, and this step might not be beneficial for every worker.
Converting a conventional 401(k) or traditional IRA into a Roth IRA usually leads to a taxable event. Nonetheless, after completing this transfer, any growth within these accounts occurs without taxes, and they won’t be touched again as long as certain conditions are met.
Suppose a 43-year-old individual secures a new position and opts to transfer $150,000 from their 401(k) to a Roth IRA. Given that this person falls within the 35% federal income tax bracket, they will face a tax liability of $52,500, ideally settled using external funds rather than those inside the IRA. Assuming the full sum in the Roth account experiences steady growth at an annual rate of 7%, after three decades, it could amass to approximately $1.14 million.
For individuals nearing retirement or those required to take Required Minimum Distributions (RMDs), if you intend to use these retirement funds personally rather than leaving them to beneficiaries, it might be prudent to keep them invested as they are.
“However, if your aim is to safeguard that retirement asset for beneficiaries,” Slott explains, “this is an excellent strategy as it eliminates the doubt around future tax rates. Switching to a Roth IRA is highly beneficial for the coming generations.”
9. Perform a Roth conversion when you're in your "semi-retirement" phase.
When your career is coming to an end and you're making less money, it might become essential to withdraw funds from your retirement account. Provided you are at least 59½ years of age, you can make withdrawals from your retirement plans without facing penalties. A 10% penalty for withdrawing funds prematurely .
This could also be a good opportunity to transfer part of your traditional IRA to a Roth IRA—particularly if you anticipate your tax bracket will increase once you reach age 73 and must start withdrawing minimum distributions. Adopting this approach might allow you to delay claiming Social Security benefits until a future date when doing so would be more advantageous. benefits will be bigger .
Go over it with your financial advisor to determine if this is suitable for your circumstances.
Bottom line
Using some skilled maneuvers and understanding how to withdraw funds from your retirement accounts can help reduce the impact of taxes. However, this is a complicated issue. finding a financial advisor Who will act in your best interests to assist you through this process may prove invaluable many times over. Here’s how you can locate an exceptional advisor.
Editorial Disclaimer: It is recommended that all investors perform their own thorough research into investment strategies prior to making an investment choice. Additionally, it should be noted that previous performance of investment products does not ensure future growth in value.