Preparing for Required Minimum Distributions (RMDs): What Wealthy Retirees Need to Know

Melissa A. Seamon, CFP®     

Senior Financial Advisor 

When retirees reach age 73, they must deal with Required Minimum IRA Distributions (RMDs).” The RMD rule requires that a minimum amount of income be taken from qualified plans starting at age 73, regardless of whether you need it. For retirees trying to defer taxes on their retirement capital as long as possible, this creates an unwanted tax liability. 

Although RMDs apply to most retirees, they can be particularly consequential for high-net-worth individuals who have accumulated substantial retirement savings in tax-deferred accounts, such as 401(k)s, traditional IRAs, 403(b)s, and other qualified retirement plans. The RMD rule is the IRS's way of telling you your free ride is over and it's time to pay up. If you're not prepared for it with a well-conceived strategy, it can significantly affect your ability to preserve wealth. 

Here's what you should know about RMDs and how to prepare for them:

Understanding Required Minimum Distributions 

As the name implies, RMDs are withdrawals mandated by the tax code that retirees must take from certain tax-qualified retirement accounts starting at age 73. The idea behind the RMD rule is that individuals should not be allowed to defer taxes on their retirement savings forever. The IRS is so intent on getting paid that it imposes a penalty of 25% on the unpaid amount in addition to taxes owed on the required amount. The IRS teases that in some cases the penalty may be reduced to 10% or waived if the RMD is timely corrected within two years.

How to Calculate Your RMD

Each year, your RMD is based on your account balance and age relative to your life expectancy. Your account balance at the end of the prior year is divided by a life expectancy factor found in the IRS's Uniform Lifetime Table. 

For example, if your retirement account balance was $800,000 on December 31, 2023, and you are currently 74 years old, you would be expected to receive retirement plan distributions for 25.5 years. Dividing your account balance by 25.5 would result in an RMD of $31,373 in 2024 to be distributed weekly, monthly, or as a lump sum. The same calculation must be done yearly to determine your next RMD amount. 

RMDs must begin by April 1 of the year following the year you turn 73 (the starting age for RMDs is scheduled to be increased to 75 in 2033 for those born in 1960 or later). 

Critical Consideration for Wealthy Retirees

Tax Planning Around RMDs

Coming out of tax-deferred accounts, RMDs are taxed as ordinary income, potentially pushing you into higher tax brackets. This can be a problem, particularly If you have income from other sources, such as investments or a pension. If RMDs significantly increase your taxable income, it could result in additional taxes on your Social Security benefits or expose you to the Medicare surtax. It's crucial to plan now to mitigate the impact of RMDs on your taxes. The most effective strategy is tax diversification, where you allocate your retirement assets among various types of vehicles to minimize the effects of taxes on your cash flow. 

For example, instead of maximizing contributions to a tax-deferred 401(k) or traditional IRA, you could steer a portion to a tax-free Roth IRA. While the contributions are not tax-deductible, withdrawals in retirement are tax-free and NOT subject to the RMD rule.  Another idea is to begin IRA distributions before RMD age in order to stretch the tax liability over a longer period of time. 

Consider investing more in taxable brokerage accounts. Under the current tax structure, capital gains tax rates (0% to 20%) are more favorable than ordinary income tax rates. Those tax rates also apply to qualified dividend income. Long-term, non-qualified investments in your retirement income mix can help mitigate your tax burden. 

Roth Conversions

If you're nearing or early in retirement, consider the advantages of converting portions of your qualified retirement account balances into a Roth IRA. Although it would trigger a significant tax event when you convert, the long-term impact of avoiding taxes at potentially higher tax rates and reducing the taxes on your Social Security can more than offset it. 

The best time to consider a Roth conversion is when your income is lower. You should do the conversion before your other retirement income streams start. To manage your tax brackets effectively, you can also plan to convert your funds gradually. 

Qualified Charitable Distributions (QCDs)

If you're charitably inclined, Qualified Charitable Distributions (OCDs) can help you satisfy your RMDs while avoiding taxable income. QCDs allow individuals over 70 ½ to donate up to $105,000 annually from a traditional IRA directly to a qualified charity. The donated amount counts toward your RMD for the year and is excluded from your taxable income.

Don't Forget Your State Taxes

While federal RMD rules apply universally to all retirees, state tax rules can vary widely. Some states don't tax ordinary income at all. However, others do impose taxes on retirement income, including RMDs. If you live in a high-tax state, such as California or New York, you face a more significant tax burden than if you live in more tax-friendly states, like Florida and Texas. 

Managing Multiple Accounts

If you have multiple tax-deferred accounts, including traditional IRAs and qualified plans from former employers, you may be required to calculate RMDs separately for each account. That's definitely the case if you have different 401(k) accounts; however, if you have multiple IRAs, they can be combined to calculate the RMD, which can be withdrawn from a single account.

 It takes coordination and a thorough understanding of the rules to manage multiple accounts efficiently. With the possibility of a penalty looming overhead, it would be essential to work with your financial advisor to ensure that RMDs are calculated and withdrawn correctly for each account. 

A comprehensive plan that accounts for tax brackets, timing, state tax implications, and charitable goals will allow you to avoid unnecessary taxes and take control of your financial future. 

Professional Assistance for Navigating RMDs 

Working with a financial advisor is essential to navigating the complexities of RMDs and integrating them into an overall retirement strategy. At Gardey Financial Advisors, we will work to create an intentional RMD plan that will make the most of your retirement savings and investments. We can provide an expert perspective and personalized planning methods to give you confidence and peace of mind as you begin your retirement. Contact us today to get started.  We best serve clients looking for exceptional client service, who value a long-term partnership, and have a minimum of $500,000.00 in investable assets.   

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