Do you own an IRA? If so, you have company. According to a 2013 study, Americans hold nearly $2.5 trillion worth of assets inside IRA accounts.1 Much of those assets are held in traditional IRAs.
Traditional IRAs, 401(k) plans and similar qualified accounts are popular savings tools because of their tax-favored treatment. You can fund these accounts with pretax dollars. Also, your growth is tax-deferred as long as the funds stay in the account. You can’t avoid taxes on these dollars forever, though.
You can defer distributions from your IRA or 401(k) up to age 70½. At that age, however, you must begin taking required minimum distributions, also known as RMDs. The amount of your RMD is based on several factors, primarily your age and your end-of-year account balance. Generally, your withdrawal will increase relative to your balance as you get older.
accordingly, you could face higher-than-expected taxes. The good news is there are steps you can take to minimize your tax burden. Below are three strategies to consider as you plan for your RMDs:
Start withdrawals earlier than required.
If the whole point is to minimize your tax exposure, it may seem counterintuitive to take distributions before they’re required. However, distributions earlier in retirement could reduce your account balance, which would then reduce the amount you’re required to take via RMDs when you turn 70½.
This could be an especially helpful strategy if you’re trying to keep your income or your tax rate under a certain threshold. A financial professional can help you carefully plan your distributions. If you take out modest withdrawals before you’re required, you may have less in your account at age 70½, which could reduce your RMDs.
Transfer your RMDs to charity.
All RMDs are taxed as income. There’s one exception to this rule, though. If charitable giving is already a part of your retirement strategy, you could donate your RMDs to your favorite organization. As long as the RMD is transferred directly from your account to the designated charity, the distribution is not taxable. The key is that you cannot take possession of the distribution at any point. You may want to work with a financial professional to ensure that the withdrawals are set up properly.
Consider a Roth conversion.
Finally, you may want to consider converting your traditional IRA to a Roth. There are no RMDs with a Roth IRA. In a Roth, your growth in the account is tax-deferred. However, your contributions aren’t deductible and your distributions are tax-free, assuming you’re over 59½ and the account has been open at least five years.
You have the option to convert your traditional IRA to a Roth. You have to pay taxes on the converted amount. Once the funds are in the Roth, however, you won’t face income taxes on growth or on future distributions. In fact, you can defer distributions as long as you want.
Ready to develop your RMD strategy? Let’s talk about it. Contact us today at Thomas Financial. We can help you analyze your needs and create a plan. Let’s connect soon and start the conversation.
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