How to Remedy Your Retirement RMD Quandary

October 2, 2017

Kent Smetters

Recently, on an episode of my radio show Your Money, I caught up with Sandra Block, senior associate editor for Kiplinger’s personal finance magazine and a former USA Today reporter and personal finance columnist for more than 15 years. In an August Kiplinger’s article, "6 Tax-Smart Ways to Lower Your RMDs in Retirement," Sandra offered advice for avoiding a big tax bill once you turn 70. Here are some key takeaways from our talk:

Sandra explained that Required Minimum Distributions, or RMDs, are amounts that the federal government requires a person to withdraw annually from traditional IRAs and employer-sponsored retirement plans once he or she reaches 70 ½ years of age. Failure to take these annual distributions can result in a tax penalty equal to 50 percent of the required distribution amount.

Once you hit 70 ½, you must begin making withdrawals from tax deferred accounts, whether you need the money or not, and pay taxes on it, Sandra said. Individuals who have saved a large sum of money and haven’t withdrawn it in the past, or have other sources of income, like a pension or a job, can get hit hard by taxes once they start withdrawing money.

Towards the end of your life, Sandra advised listeners, they should have very few assets left in their accounts. A lot of people have saved very aggressively for retirement, which is not a bad idea, especially with out-of-pocket medical expenses and concerns about the projected future state of Medicare.

So what are some ways to manage your taxes?

  • Don’t wait until you’re 70 ½ to withdraw from your 401k or IRA for the first time. "If you take modest withdrawals over the years, you will shrink the account and the RMD will be smaller too," Sandra said. "Calculate how much you can afford to withdraw and use that money to delay filing for Social Security. The longer you delay, the bigger your benefits will be."
  • Keep working! A lot of people today are working past age 70. You don’t have to take RMDs from your employer’s 401(k) as long as you’re still working, even if you’re older than 70 ½. Once you quit, however, you have to do so. The downside is, if you have an IRA or 401(k) from a previous employer, you still have to take RMDs. Some employers will let you roll your previous employer’s 401(k) into your current one if you can consolidate. This provision will become more relevant as people continue working longer.
  • Donate your RMD. This new provision allows you, once you’re 70 ½, to make a direct transfer of up to $100,000 from your IRA to a qualified public charity, money that is not subject to RMDs. This is a nice tax break for older individuals. They can support an institution that they like. But it’s important to PLAN for it. If you can work it into your long-term plan and you have enough money to make regular contributions, it’s a very thoughtful provision and an important one as well.
  • Convert to a Roth IRA. After you convert money into a Roth IRA, you never have to take RMDs or pay taxes on it, Sandra said. But " you still have to pay taxes on anything you convert. Convert just enough to avoid moving into a higher tax bracket. After the conversion, that money will grow tax free for as long as you live. Let it sit there or give it to your kids.
  • Invest in a Qualified Longevity Annuity Contract (QLAC). This is a new product that hasn’t caught on yet, Sandra said. A QLAC is an annuity contract that is purchased within a traditional retirement plan, under which the annuity payments are deferred until age 85 in order to provide retirement income security later in life. "Once you turn a certain age, you know you’ll get a guaranteed payout every year. If you think you’re going to live a long time, it’s like an insurance policy against running out of money."
  • Rejigger your investments. Use your tax-deferred accounts for bonds and bond funds and your taxable accounts for stocks and stock funds, Sandra said. It’s likely you will have fewer gains in bond-heavy retirement accounts.

Kent Smetters is the Boettner Professor of Business Economics and Public Policy and faculty director of the Penn Wharton Public Policy Initiative at the Wharton School of the University of Pennsylvania.