Required minimum distributions (RMDs) from tax-deferred accounts can be a significant amount of money for some individuals, especially with the minimum age for starting to take RMDs now at 73 or 75. If you do not need this money for living expenses, you may be wondering where to stash it. One option is to reinvest the unneeded RMDs, and a Roth IRA could be a good choice as withdrawals from Roth accounts are tax-free. However, you cannot directly convert RMDs to a Roth IRA. A potential workaround for some individuals is to contribute to a Roth IRA if they have enough earned income.
The IRS defines earned income as money earned through work, such as wages, commissions, bonuses, tips, and self-employment income. Income from sources such as pensions, interest, dividends, and Roth IRA withdrawals do not qualify as earned income. Additionally, there is an income limit for Roth contributions, and a five-year waiting period after the first contribution to any Roth account. Inherited Roth accounts must be withdrawn within 10 years. If you do not qualify to contribute to a Roth IRA, there are other options to eliminate, reduce, or delay your RMDs, such as a Roth conversion, charitable contributions, or continuing to work to delay RMD requirements.
Structuring your retirement withdrawals to reduce taxes involves considering all sources of income, including retirement accounts, RMDs, Social Security benefits, pensions, and taxable investment income. Coordinating taxes between spouses and exploring strategies like investing in tax-free bonds or relocating to a state with no income or estate tax can help minimize tax burdens in retirement. Consulting a financial advisor can provide personalized advice on managing RMDs and maximizing tax efficiency in retirement. Planning ahead and estimating retirement taxes before starting to collect pensions and Social Security can help you make informed decisions about your financial future.
It is important to be aware of the penalties for failing to take an RMD within the required time frame, which can be up to 50% of the missed RMD amount. Working with a financial advisor can help navigate the risks and tradeoffs in your specific situation. Taking advantage of tax-efficient strategies and coordinating retirement income sources can optimize your retirement savings and help you work towards your financial goals. Consider speaking with a financial advisor to develop a tax-efficient retirement plan tailored to your individual circumstances and objectives.
