5 Strategies to Take Control of Your Required Minimum Distributions (RMDs)
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When you contribute money to a pre-tax retirement account, like a traditional 401k or IRA, you receive a tax deduction. In addition, your invested dollars inside of the account, they grow tax-free, but there's no free lunch. In the future, when you withdraw money from your pre-tax accounts, the withdrawals will be taxed as ordinary income. And whether you want to or not, at age 73, the IRS is going to knock on your door and force you to begin to take taxable withdrawals each year.

These forced withdrawals are known as required minimum distributions or RMDs, and they act as a safeguard against people using a retirement account to avoid paying taxes. In other words, RMDs ensure that the IRS receives their share of taxes on this bucket of money that's never been taxed before.

Your first RMD at age 73 will represent about 4% of the account balance and will continue to increase as you get older. So if you have $1 million in a pre-tax IRA at age 73, your first required minimum distribution will be around $40,000, which will be taxed as ordinary income.

For retirees who rely on their pre-tax accounts to pay for living expenses in retirement, this forced taxable withdrawal isn't an issue. They need the money and would be taking a withdrawal even if the IRS wasn't forcing them to.

But for those who don't need the income, either because they have other income sources or more tax efficient account types to withdraw from, RMDs can be a giant burden. Unwanted taxable distributions can spike your tax bill, cause social security income to become more taxable, and even cause Medicare premiums to increase due to those pesky IRMA surcharges. Since RMDs are, as the name implies, required, many people think that they lose all control over these taxable distributions once they begin.

But that's not necessarily the case.

Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm sharing five often overlooked strategies that can help you gain more control over your current or future required minimum distributions. In addition to giving you more control, these strategies can help lower taxes, reduce catastrophic risks, and improve risk-adjusted investment returns. To view the research and articles referenced in today's episode, just head over to youstaywealthy.com forward slash 221.

In 1986, the Tax Reform Act introduced the concept of required minimum distributions, or RMDs, requiring account holders to begin withdrawals from their pre-tax retirement accounts once they reached age 70 and a half.

In 2019, over 30 years later, the Setting Every Community Up for Retirement Enhancement Act, I don't know who comes up with these, but it's better known as the SECURE Act. This act increased the RMD age to 72. And then most recently in 2022, the SECURE Act 2.0 increased their RMD age again to age 73 for those born between 1951 and 1959.

The SECURE Act 2.0 also increased the RMD age to 75 for those who were born in 1960 or later.

So for those listening who have not started taking required minimum distributions yet, you will be taking RMDs at either age 73 or age 75, depending on your date of birth. But to keep things simple, we're going to use age 73 for today's discussion. So at age 73, the IRS is going to begin forcing you to take distributions from your pre-tax retirement accounts, and your first distribution will be equal to roughly 4% of the account balance.

For context, the distribution rate jumps up to just over 6% around age 85 and just over 11% at age 95. So if you have $1 million in a pre-tax retirement account at age 95, the IRS will force you to take out around $111,000, which will be taxed as ordinary income.

If you don't need or want those taxable distributions, or you simply want to mitigate the tax burden that they cause and gain more control over this bucket of money, I'm going to share five proactive strategies for you to consider. The first two strategies are fairly well known. I didn't want to exclude them just in case someone listening could benefit, but I will breeze through them quickly and then we'll dig into the more unique ones after. So the first is to consider proactive Roth conversions ahead of turning age 73, ahead of RMDs kicking in.

I've talked at length about Roth conversions here on the show. So again, I'll keep this brief, but in short, a Roth conversion is the process of voluntarily transferring money from a pre-tax retirement account, like a traditional IRA into an after-tax Roth IRA. The amount that's being transferred, i.e. converted is taxed in the year that you make the conversion, but that money is permitted to live and grow tax-free inside a Roth IRA for as long as you want it to.

And what's great is that any future withdrawals taken from a Roth IRA are tax-free. Also, RMDs do not apply to Roth accounts because the tax bill on those savings has already been satisfied. And for those thinking about their estate planning for the next generation, Roth IRAs can be inherited by your heirs tax-free.

While you can do Roth conversions at any age, most people aggressively pursue them during their gap years. Your gap years begin the year that you retire from work and end when RMDs begin. They're commonly referred to your gap years because there's a gap in income. And as a result, most people find themselves in the lowest tax bracket they've ever been in.

As you might already know, the amount of your RMD is based on the value of your pre-tax retirement account and your age or life expectancy. In other words, the larger your account balance is and the older you are, the higher your minimum distribution will be. With that in mind, since Roth conversions reduce the balance of pre-tax retirement accounts, RMDs will in turn also be reduced.

RMDs can also be eliminated entirely if a person happens to have a long runway to process tax efficient Roth conversions and can convert all of their pre-tax money before they hit age 73. So proactive Roth conversions ahead of turning age 73 or 75, if you fall into that camp can be one strategy to reduce future RMDs. And if done properly can also significantly reduce your long-term tax bill.

If you want to learn more about Roth conversions, the pros and cons, and who should and shouldn't consider them, I'll link to the episodes that I publish in today's show notes, which can again be found by going to youstaywealthy.com forward slash 221.

Okay, the second well-known strategy that can help reduce or even eliminate RMDs is known as a Qualified Charitable Distribution, or QCD. A QCD is a distribution from your pre-tax IRA to one or more qualified nonprofit organizations. Since the money is going to a qualified nonprofit, the distribution is not taxed.

And while RMDs don't begin until age 73, you can actually start doing QCDs at age 70 and a half, allowing you to start reducing your IRA balance a few years ahead of your first required distribution.

Perhaps the most attractive part about QCDs, aside from giving money to charities in need, is that they can satisfy some or all of your annual required minimum distribution. For example, let's say that you turn 73 this year and your first RMD is $40,000.

Let's also say that you are charitably inclined and you don't need or want that $40,000 taxable withdrawal. You'd rather give it to charity in need and avoid the taxable income. If that's the case, you can process a $40,000 QCD to the charity or charities of your choice from your pre-tax IRA this year. And not only will you be fulfilling your charitable goals, but you will be satisfying your RMD and escaping the taxable income.

Keep in mind here, there is not a minimum QCD amount. Any amount that you process as a QCD will help reduce the amount of your required minimum distribution. For example, if you only give $5,000 through a QCD this year, then your RMD will be reduced to $35,000 instead of $40,000.

Now, while there is not a minimum, there is a maximum of $105,000 per person per year. But since the maximum limit is per person, this means that a married couple can each process their own QCD for a total of $210,000 as long as both spouses each have a pre-tax IRA. In other words, my $105,000 QCD cannot come from my wife's IRA. It must come from my own.

Okay, a few other important things here before we move on. Number one, QCDs cannot be processed from employer plans like 401ks and 403bs. They can only be made from traditional IRAs, inherited IRAs, and inactive, simple, and SEP IRAs. They must also be directed to a qualified nonprofit, and not all nonprofits qualify, so be sure to check with your advisor or custodian before you do anything.

Number two, you cannot make a QCD to a donor advised fund or a private foundation. You also cannot benefit from their donation being made. For example, a QCD cannot be used to purchase tickets to a charity event or a round of golf or a charity auction item.

Number three, you can process one lump sum QCD to one charitable organization or process multiple QCDs for different organizations in different amounts. In other words, if you want to do a total of $10,000 in QCDs this year, you can distribute $10,000 to one organization, $500 to 20 organizations, or any combination that meets your goals.

And then lastly, the Secure Act 2.0 provided a unique opportunity to use a QCD to fund a charitable remainder unit trust, also known as a CRUT, a charitable remainder annuity trust or a CRAT, or a charitable gift annuity, a CGA. This new rule essentially allows owners of pre-tax traditional IRAs to move up to $53,000 during their lifetime to one of these unique account types without tax or penalty.

Now, these are very unique account types and not fitting for everyone. Also, there are several hurdles and nuances that must be satisfied and understood before taking action. So please talk to your trusted advisors before taking action to determine if it's a good fit for you.

While I'm a huge fan of donor advised funds, especially during high income years or years where someone is pursuing aggressive Roth conversions, QCDs can be a really tax smart way to meet your charitable giving goals later on in life with those pre-tax dollars that you don't want or need.

But before you start processing QCDs, I want to share one really important tip with you. And that is that QCDs are generally reported as a normal distribution from your retirement account on form 1099 and therefore included in your taxable income. In other words, your custodian, Fidelity, Schwab, Vanguard, et cetera, your custodian will not indicate that the distribution was a QCD.

Okay.

Okay, the third strategy for gaining more control over RMDs applies to people over age 73 who are still employed and still eligible to participate in a workplace 401k retirement plan. The IRS allows retirement savers in this situation to delay RMDs from their workplace 401k until the year they retire as long as they don't own more than 5% of the company that they're working for.

The reason I bring this up is that many 401k plans allow participants to transfer or roll external pre-tax dollars into the plan. So if, for example, you have a pre-tax IRA that's exposing you to RMDs in the upcoming future, your company may allow you to roll those dollars into your 401k plan, enabling you to delay all RMDs until you finally stop working.

While this strategy does give you more control over your required distributions and does have some great use cases for the right person, I hope it's clear here that you're not avoiding taxes or avoiding RMDs. You're really just kicking the tax can down the road. In fact, you're kicking a growing tax can down the road, and that's because your pre-tax dollars are continuing to grow in your 401k while you continue working and delaying your RMDs.

We call this a growing tax liability. The larger your pre-tax accounts get, the larger your check to the IRS will be. For example, let's say that you're 73 years old and you have a total of $1 million in your pre-tax account bucket. If

If you retired now, your first RMD would be about $40,000. But if you kept working and you rolled that $1 million into your workplace 401k and it grew to, let's say $2 million by the time you reach 85 and officially retire, your first RMD at age 85 with a $2 million account balance will be closer to $125,000, more than three times the original amount.

Depending on your tax situation, it's possible that beginning to take smaller distributions at age 73 would have been more prudent than letting all of your pre-tax assets grow and then getting hit with a much larger taxable required distribution that will just be quickly increasing each year as you get older from there.

So if you happen to meet the criteria for this strategy, just be sure to crunch the numbers and work with your trusted advisors to determine if it truly makes sense to delay some or all of your RMDs while you continue to work.

Okay.

So as a refresher, all the IRS cares about when it comes to RMDs is that you take out the minimum required amount each year. The minimum required amount, again, is based on your age, life expectancy, and the balance of your pre-tax retirement accounts as of December 31st of the prior year.

Given that your RMD amount changes year to year, your custodian, Fidelity Schwab Vanguard, your custodian and your financial advisor will provide the updated amount to you each year and usually send several reminders to ensure that you don't forget to take your mandatory withdrawal. Again, all the IRS cares about is that the minimum amount is withdrawn, allowing them to collect their share of the taxes that you've been deferring for potentially decades.

You can certainly withdraw more than the minimum if wanted or needed, but doing so is only going to increase your taxable income, which could have unwanted ripple effects in other areas of your plan.

Also, it's worth me reminding listeners that you don't need to spend your RMD withdrawal. If you don't need or want the money, you can just transfer the RMD amount to your plain vanilla brokerage account and invest the proceeds as you see fit. You could also just park it in cash somewhere until you decide what you want to do with the proceeds.

Now, whether you intend to spend the required distribution or reinvest it, you have an important asset allocation decision to make when determining what investment or investments you are going to take your RMD from. And that's because unless you're a doomsday prepper with an all cash portfolio, processing the withdrawal each year will naturally require you to sell one or more securities in your account.

To keep it simple, let's say that you have four investments in your pre-tax IRA. You have a money market fund, i.e. cash, a US stock fund, an international fund, and a bond fund.

If we experience a year like 2022 where both global stocks and bonds are down, it may be wise to take that year's RMD from your money market fund instead of selling asset classes that are in negative territory. Or how about this year where we have U.S. stocks significantly outperforming international stocks?

If you were to process your RMD today, it might be wise to take the majority of it from your US stock fund, allowing you to take some gains off the table, i.e. sell high and reduce concentration risk in that asset class. Now, while I don't advocate for having a complex portfolio with hundreds of securities, getting slightly more tactical and owning a few more asset classes can provide more opportunities to manage investment risk during your RMD years.

For example, maybe instead of four broad-based investment funds, you own something closer to eight or 10. Perhaps instead of just owning one US stock fund, you own a growth fund, a value fund, and a small cap fund. And instead of one international fund, you own a developed international fund and an emerging markets fund.

In this scenario, when you take your RMD, you have the ability to be more tactical in selecting where you take your withdrawal from. Here in 2024, it's not just U.S. stocks across the board that are outperforming. It's U.S. growth stocks specifically that are having another record year. So given that you have a few more slices in your portfolio, you might decide to take the majority of your RMD from the U.S. growth fund that you own, reducing your concentration risk and locking in some of those gains.

A simplified approach to following this strategy is just to follow a basic rebalancing policy, i.e. instead of choosing a specific security or fund to sell and take your RMD from, you could just rebalance the entire account per your documented investment policy statement and

increase your cash position to the desired level at the same time in order to process that year's RMD. While it still does require some number crunching or access to a portfolio rebalancing tool, this approach takes the guesswork out of everything. It also mitigates the chances that your emotions get in the way.

Some things have gone up in your portfolio, some things have gone down. So you simply rebalance all positions back to their target allocation after factoring in the amount that you need in cash in order to process your RMD. And since it's a pre-tax IRA, you don't have to worry about capital gains taxes. You can buy and sell and process your rebalance without worrying about triggering any taxes.

Now, one potential downside to this simplified approach is that it could lead to rebalancing too often. And rebalancing too often can sometimes have negative effects, like curbing the momentum of investments that are doing well and may be poised to continue doing well. But in retirement, I would argue that most people are likely okay with taking some risk off the table, even if it means losing out on a few extra percentage points. So you may still determine that this is the right approach for you.

Two quick things before we move on here. Number one, if you have multiple pre-tax IRA accounts, you can take your full RMD from just one of the IRAs. In other words, each IRA does not have its own mandatory RMD. They're all kind of lumped together in the IRS's mind.

So for example, if you have three IRA accounts, each with a different investment strategy, and your total RMD across all three accounts this year is $40,000, you can take the entire $40,000 from just one of the accounts. Why would you do this? Well, maybe one of your accounts is primarily invested in high growth tech stocks and taking your RMD from that account that has performed very well over the last decade is your simplified approach of taking chips off the table and reducing risk.

Or maybe you're following an asset location strategy and tactically taking withdrawals from certain accounts helps you keep your strategy intact. Just know that this strategy does not apply to 401ks. In other words, you cannot take an RMD associated with your 401k from an IRA. You must calculate the RMD amount for the 401k and take it from the 401k. Now,

Number two, I'm often asked, when is the best time to take your RMD during the year? Should it be taken at the beginning of the year or the end? Should it be taken out all at once or distributed monthly or quarterly? The textbook answer is to let the investments grow tax deferred for as long as possible and take your RMD out at the very last minute on December 31st.

However, given the growing volume of year-end activity, many custodians are now forcing account holders to process them a few weeks before the year-end deadline just to avoid any processing hiccups that could cause an RMD to get missed. While taking your RMD in November or December instead of January or February, while that's the textbook answer, the extra little time that your money has to grow tax-deferred likely won't make a huge dent in your long-term plan.

Remember, there's the textbook answer and then there's your answer. If you prefer to take your RMD at the beginning of the year or you prefer to break it up into monthly or quarterly payments because that's what works best for you, then do it. This is not a decision that will make or break your plan.

Okay, the last strategy to discuss today is something I've touched on in a prior episode, but based on many of the conversations I've had so far this year, it seemed to fly under the radar. And that is to earmark some or all of your pre-tax IRA dollars to tax efficiently pay for a long-term care event in retirement.

This strategy essentially takes advantage of the often overlooked medical expense deduction or IRS publication 502. In short, medical expenses, including long-term care costs, can be deducted on Schedule A of your tax return. The full-length publication even has a clear definition of long-term care services inclusive of a section dedicated to nursing homes.

Specifically, it states, quote, you can include the cost of medical care in a nursing home, home for the aged or similar institution for yourself, your spouse or your dependents. This includes the cost of meals and lodging in the home if the principal reason for being there is to get medical care.

It continues by saying that you can also include, quote, the cost of lodging not provided in a hospital or similar institution if it meets certain criteria. Simple things like the lodging must be primarily for medical care. There has to be a licensed doctor there. Lodging isn't extravagant, etc.,

More often than not, when we do a long-term care analysis for a client, the conclusion is that they should skip buying long-term care insurance and instead plan on self-funding. I.e., if a long-term care event occurs, the cost will be paid out of pocket by the client instead of tapping into an insurance policy.

One way to implement a long-term care self-funding plan is to carve out a certain dollar amount from retirement savings and put it in its own individual investment account earmarked specifically for a future potential long-term care event. This, in my mind, allows the client to keep the money invested, perhaps invest it a little bit differently given that it has a different goal than their other retirement savings and compartmentalize exactly what those dollars are for.

In some cases, a client's nest egg may be comprised mostly of pre-tax IRA dollars, or they need the after-tax money that they do have to fund other near-term expenses.

In these cases, we'll simply open up another pre-tax IRA for the client and transfer the amount that we've decided to earmark for long-term care from their primary IRA to this newly opened IRA. It's a lateral transfer from one pre-tax IRA to another, so there's no tax consequences here. We're just creating a bucket, if you will, that's specifically setting aside and earmarking dollars for a potential long-term care event in the future.

by keeping these funds in their own account, we prevent everything from getting commingled and we can sleep at night knowing that there's a plan for a potential long-term care event in the future. We're not just saying that we will self-fund and hoping nothing happens. We're taking action and earmarking dollars for that potential event, planning for the worst and hoping for the best.

So if money earmarked for long-term care expenses is in a traditional IRA and a long-term care event occurs in retirement, the client can take money out of that pre-tax account to pay for medical expenses. And yes, taking money out of the IRA is a taxable event. However, the client can immediately turn around and deduct the qualified medical expenses on Schedule A of their Form 1040.

One important thing to take note of here is that the IRS only allows you to deduct the amount of your total medical expenses that exceed seven and a half percent of your adjusted gross income or AGI. So if your AGI is a hundred thousand dollars, you can only deduct expenses above $7,500. If your AGI is near $0 because you don't have any taxable income sources, keep in mind that the IRA withdrawal in this example will cause your AGI to spike. For

For example, let's say that you have $100,000 of long-term care expenses in one year. All you have is pre-tax IRA dollars to pay these expenses. So you withdraw $100,000 from your IRA. That $100,000 will now be added to your gross income and you'll only be eligible to deduct expenses above $7,500 or 7.5% of your AGI.

While you weren't able to deduct the full $100,000, you were still able to get funds out of your pre-tax IRA at a very favorable rate. And going full circle here back to RMDs, when you take money out of a pre-tax IRA, it reduces your account balance and in turn reduces your RMDs.

Taking money out to pay for a long-term care event is not as fun or as tax efficient as taking money out to process a QCD, but it's still a tax-friendly way to use those dollars while also making a dent in future RMDs that you may not need or want.

Now, you might be thinking, this is great, Taylor, but it doesn't really give me control over my RMDs. I don't really want to bank on having a long-term care event just so I can reduce my future required distributions. And I get that. It's very true. But I would still argue that you are making proactive planning decisions here about things that you do have control over.

over. And by making those decisions intelligently in advance, you are improving your overall plan. You're reducing risk and you're staying focused on important things that you can control. We don't buy home and auto insurance because we hope to be able to use it. We buy it because we want to gain control over catastrophic risks that could destroy our plan. I think it's safe to say that most people would prefer to plan and prepare for a long-term care event than just cross their fingers and hope it never happens.

And if the plan that's ultimately implemented combats the risks of a catastrophic long-term care event while also mitigating taxes and potentially reducing unwanted required distributions in the future, then that sounds like a win to me. We started today's conversation talking about Roth conversions as a way to reduce future RMDs.

And one common concern I hear from those pursuing Roth conversions is that they're worried they won't be able to tax efficiently convert all of their pre-tax dollars before those RMDs begin.

But knowing that the pre-tax dollars remaining can be tax-efficiently earmarked to pay for a long-term care event, which would in turn reduce future RMDs, often helps them feel better about intentionally hanging on to some extra IRA assets. It can also help prevent someone from doing ultra-aggressive Roth conversions in an attempt to convert everything before age 73, which could result in overpaying the IRS.

Okay, really quick before we wrap up, you might have caught me earlier saying that the IRS also allows you to deduct medical expenses, including eligible long-term care expenses for dependents, which presents another interesting use case here. For example, you may not have a long-term care event, but it's possible that you end up caring for an aging parent who does have one, or maybe they need nursing care.

If they meet the criteria to be claimed as a dependent and you determine that claiming them as a dependent is best for your situation, you can deduct those eligible medical expenses that are incurred on your tax return and apply the same concepts that I've discussed here today. We went through a lot today. So let's quickly recap the five ways you can gain more control over your required minimum distributions. Number one, Roth conversions during your gap years. Number two, qualified charitable distributions or QCDs.

Number three, rolling those pre-tax IRA dollars into a 401k if you're still working. Number four, withdrawing RMDs from the most appropriate asset classes. And number five, earmarking pre-tax IRA dollars for a potential future long-term care event.

If you want to continue your learning journey on this topic, I'll be sharing all of the supporting articles and research that helped with today's episode in the show notes, which can again be found by going to youstaywealthy.com forward slash 221. Thank you as always for listening, and I will see you back here next week. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.