Required minimum distribution (RMD) strategies

A Required Minimum Distribution (RMD) is the minimum amount you have to withdraw from your retirement account each year. When you reach the age of 73, you must start making withdrawals from retirement accounts such as traditional IRAs, SEP IRAs, SIMPLE IRAs, and retirement plan accounts such as 401(k)s. If you don’t take your RMDs on time, it can result in a 25% penalty of the amount that should have been withdrawn, but this can be reduced to 10% if you take action soon after the missed deadline. At the same time, Required Minimum Distributions are subject to regular income taxes. That’s why many people want to know how to reduce RMD taxes.

The calculation of the amount you need to take each year is based on two things: your age and the balances of your retirement account at the end of the previous year. The IRS provides a life expectancy factor, which is also known as the corresponding distribution period, for each age. 

By dividing the amount you have in your retirement account on December 31 by the life expectancy factor, you’ll get the estimated amount you have to take from your retirement account in the current year.

You can also use an RMD calculator or have a look at our example calculation:

$960,000 (previous year-end account balance) ÷ 26.5 (distribution period at age 73) = $36,226.42 (RMD). 

The life expectancy factor decreases with age, which increases the percentage of your balance that must be withdrawn. Here’s a sample from the IRS Uniform Lifetime Table:¹

By withdrawing RMDs, there might be additional taxes on the amount of missed or insufficient RMDs. So, it’s important to know when and how much you need to take from your retirement account. Also, depending on your retirement plan, the extra income after the withdrawal can create a tax drag on your portfolio’s growth and may potentially be taxed at higher marginal tax rates.

If you’d like to reduce your tax-deferred balances and lower your future RMDs, it might be helpful to consult a retirement financial advisor or a tax or legal advisor. The following required minimum distribution (RMD) strategies might also help:

You can start withdrawing funds from retirement accounts such as IRAs or 401(k)s at age 59½ without incurring a 10% penalty. That’s the earliest opportunity for withdrawals. Then again, waiting longer could mean larger savings to draw upon.

By targeting a specific tax rate for your distributions, you can avoid falling into a much higher tax bracket. By tapping both taxable brokerage accounts and tax-deferred accounts before RMDs kick in at age 73, you may be able to reduce the overall size of your retirement accounts. It may also be possible to defer claiming your Social Security benefit (which increases 8% for every year before claiming until the age of 70).

You can read more about retirement withdrawal strategies. But before making a decision, it might be best to work with a financial advisor to determine if the tax savings outweigh the potential growth by not withdrawing.

The second required minimum distribution strategy is a Roth conversion. This strategy might help you increase your financial flexibility in retirement. But keep in mind that once your RMDs kick in, you must take your RMD for the year before converting additional funds to a Roth IRA — RMD amounts themselves cannot be converted.

By converting your traditional IRA funds into a Roth IRA, you have to pay taxes on the converted amount. But once the assets are in a Roth account, their potential growth is tax-free. And, by meeting certain conditions, withdrawals aren’t subject to federal income tax. Plus, Roth IRAs don’t have RMDs during the account holder’s lifetime, so a conversion might help reduce the amount in the traditional retirement account and also the RMDs. That can lead to potentially lower distributions and help avoid higher taxes.

While a conversion may not be the right choice for everyone, there are still a few situations in which it might make sense, including:

• You expect to be in a higher tax bracket later in retirement

• You want to reduce the size of your traditional IRA to lower future RMDs

• You hope to leave tax-free assets to your heirs

Since a conversion increases your taxable income in the year it’s done, it can be a good idea to consult a tax or legal advisor to weigh the pros and cons based on your situation.

Another strategy for how to reduce RMD taxes and support causes you care about is through making a qualified charitable distribution (QCD). With a QCD, funds from an IRA are transferred directly to a qualified charitable organization. These distributions are excluded from your taxable income.

To be eligible, you must be at least 70½ years of age. For 2025, you can donate up to $108,000 per individual from your IRA using a QCD (subject to inflation adjustments). Keep in mind that the donation must be made directly from the IRA custodian to the charity to qualify.

If you’re worried about outliving your savings, using your RMDs to purchase an annuity with guaranteed income might be a good option. Annuities can offer competitive after-tax yields and a certain minimum income for your life and/or the life of your spouse, which can help reduce the risk of outliving your nest egg. However, not all annuities have the same benefits, so it’s important to consider your options and choose one carefully based on your desired retirement.

Saving for retirement is a long process that requires the right tools and knowledge. By complementing your traditional retirement accounts with additional savings accounts, you may create more opportunities to grow your savings and fund your retirement. Compare the top rates on competitive high-yield savings accounts and start preparing for your retirement today.

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.

Sources

¹https://www.irs.gov/publications/p590b