For decades, you’ve saved diligently in retirement accounts like traditional IRAs and 401(k)s. But once you reach age 73, the IRS requires you to begin withdrawing money each year, whether you need it or not. These withdrawals, called Required Minimum Distributions (RMDs), can have a significant impact on your taxes and long-term retirement plan. Understanding how RMDs work and how to manage them can help you keep more of your hard-earned savings.
How RMDs Work
An RMD is the minimum amount you must withdraw annually from certain retirement accounts once you reach age 73. These accounts include traditional IRAs, SEP IRAs, SIMPLE IRAs, and most employer-sponsored retirement plans, such as 401(k)s. Roth IRAs, however, are exempt during the original owner’s lifetime.
The IRS calculates RMDs based on your account balance at the end of the previous year and a life expectancy factor from IRS tables. Each year, the percentage you must withdraw increases as you age. Failure to take the correct RMD can result in steep penalties, historically as high as 50% of the shortfall; however, recent tax law changes have lowered these penalties in some cases.
Tax Implications of RMDs
RMDs are generally taxed as ordinary income, which means they can push you into a higher tax bracket if not planned carefully. Large withdrawals may also increase the taxes you owe on Social Security benefits or raise your Medicare premiums.
Because RMDs are unavoidable, it’s important to anticipate their impact. Some retirees choose to spread withdrawals evenly throughout the year, while others take them in a lump sum. The timing doesn’t affect your total tax bill, but planning helps avoid surprises when tax season arrives.
To help you coordinate income streams effectively, see Social Security Claiming Strategies That Could Save You Thousands.
Strategies to Minimize the Burden
While you can’t avoid RMDs entirely, you can use strategies to lessen their impact:
- Roth Conversions: Converting portions of a traditional IRA into a Roth IRA before age 73 can reduce the balance subject to RMDs later. Roth withdrawals in retirement are tax-free, offering flexibility.
- Qualified Charitable Distributions (QCDs): If you’re charitably inclined, you can donate up to $100,000 annually directly from your IRA to a qualified charity. This counts toward your RMD but isn’t taxable income.
- Coordinated Withdrawals: Withdrawing strategically before 73 can spread out taxable income over more years, preventing large spikes later.
Working with a tax advisor or financial planner can help you tailor these approaches to your situation. For more ideas on tax efficiency, check out Tax-Smart Moves to Make Before Retirement.
Common Mistakes to Avoid
The most common mistake is simply forgetting to take an RMD, which can trigger penalties. Another error is withdrawing from the wrong account type, especially if you hold multiple retirement accounts. Each IRA must be calculated separately, although RMDs can be aggregated across them; 401(k)s, on the other hand, must be handled individually.
Some retirees also underestimate the effect of RMDs on other financial areas, such as healthcare costs or estate planning. Failing to integrate RMDs into your broader retirement strategy can result in higher taxes or reduced flexibility for your heirs.
To ensure your financial legacy stays on track, see Estate Planning Essentials for Families Over 50.
The Bottom Line
RMDs are a fact of retirement life after 73, but they don’t have to derail your financial plans. By understanding how they work, preparing for their tax implications, and employing smart strategies, you can maintain control over your retirement income. With proper planning, RMDs become just another step in ensuring your money supports you throughout your life.
