Strategizing Required Minimum Distributions

The IRS tax laws affecting retirees are ever-so changing. It is important for senior citizens to understand the dynamic changes so they can maximize their retirement savings growth, income, and estate to heirs. Knowing various strategies and tactics on how and when to take distributions from retirement accounts will help you trim what you would owe to our most dreadful Uncle Sam.

In the last two decades, the U.S. stock market has been in a massive bull market. Retirement accounts have performed quite well. More than $13 trillion in savings is currently accounted for in tax-deferred retirement plans, in which seniors will have to pay taxes upon receiving distributions. With the combination of capital gains, risk of tax increases, and bumping into higher tax brackets as your ordinary income increases, the tax bill could be quite gruesome.

The Required Minimum Distribution (RMD) age limit is trending right (older) to account for longer average life expectancies. The IRS looks at this to protect seniors from outliving their money. This limited relief in the RMD timeframe should be taken advantage of, but not in the sense of delaying your distributions further. The “R” in RMD is a requirement and should not be ignored—unless you want to pay a hefty 50% tax penalty on an amount short of RMD. But you can start taking distributions earlier at no penalty (between 59.5 and RMD age). These earlier distributions can help you best leverage how much and when you want to take distributions based on your financial needs and portfolio performance. Taking distributions early in retirement years will help you offset your need for Social Security and will give you the opportunity to delay and maximize the benefits. During this time, you may be in a lower tax bracket (because taxable income can decrease during retirement) and afford to receive your distributions as ordinary income without bumping up to another tax bracket.

Additionally, taking distributions earlier than required gives you leverage as to when to take them based on market performance that will affect your capital gain exposure. Paying more capital gains on up years, or taking distributions during down years (sequence of returns) can cripple your investment portfolio. The earlier you start taking distributions will significantly reduce the amount of RMD down the road.

Another strategy a retiree can use during RMD years is to set up qualified charitable distributions (QCD). You can donate up to $100,000 through QCDs within your retirement accounts that count toward your RMD. This will reduce your adjusted gross income which will inherently reduce your federal/state income taxes and possibly social security taxes and Medicare costs.

So, for those who faithfully and willingly donate to a good cause out of pocket through their ordinary income, they can do so through their RMD during retirement instead—a WIN/WIN!