At some point in your life, it is likely that you will be subject to a required minimum distribution (RMD). There are two life events that can trigger an RMD:

  1. You turn 70 ½
  2. You inherit an Individual Retirement Account (IRA)

An RMD is an annual distribution percentage based on an IRS life expectancy table. These distributions force you to recognize taxable income in the amount of the distribution. Most people choose to take these distributions at the end of the year, but that isn’t the most tax efficient way to manage your RMD.

Over 70 ½  

Instead, take the steps below to maximize the time value of money and tax efficiency of your RMD if you are 70 ½ or older:

  1. As soon as you file your taxes, determine your tax liability from last year’s state and federal tax returnsl. Take a distribution from your Traditional IRA in the amount of your total RMD minus your federal and state taxes that you paid last year.

Benefits: This moves some of the money out of your Traditional IRA as soon as possible which reduces future RMDs because the money doesn’t grow for the full year within the Traditional IRA.

2. Move the distribution to your taxable brokerage account and invest the money according to your overall investment plan.

Benefits: Your tax rate on qualified dividends and long-term capital gains are typically half that of your ordinary tax rate. By allowing the rest of the year’s gains to be accrued in your brokerage account, you will lower your overall tax rate on all future income. 

3. With the remaining balance of the RMD, send it as a federal and state withholding tax payment in December or before your tax year ends.

Benefits: By sending the money through withholding instead of quarterly estimate payments, the IRS views it as being sent evenly throughout the year and will result in no estimated penalty tax by sending the equivalent amount of your last year’s taxes. This allows you to keep your money for the longest amount of time.

4. Repeat each year.

Benefits: Doing this each year will compound the benefits of the tax savings. You will deplete your Traditional IRA quicker by taking money out earlier in the year but sending your tax bill to the tax authorities at the latest possible point. This maximizes your wealth on all sides of the equation.

If you are over the age of 70 ½, you also have another option that will satisfy your RMD. This is called a Qualified Charitable Distribution (QCD). A QCD is when you send money to a 501(c)(3) charitable organization from your Traditional IRA without ever touching the money yourself. This direct transfer is crucial — without it, the special deduction can be disallowed. A QCD will count towards your RMD but will wipe the income away from your tax return in the amount of the QCD. This above-the-line deduction can make charitable giving beneficial to those who take the standard deduction. It also reduces your adjustable gross income which could affect your Medicare Income Related Monthly Adjustment Amount (IRMAA). Even if you only do $20 per week to your church, consider setting up the transfer through your IRA so that you can get a full deduction for charitable giving. In consideration with the strategy above, it would be best to wait until December to make your QCD for the year. Reduce your distribution at the beginning of the year by the amount of charitable giving you plan to do to fully implement the plan.  

Inherited IRA

If you are subject to an RMD due to an inherited IRA, we generally recommend taking the whole distribution as early as possible. You can then offset the tax burden by deferring more income into your 401(k) at work. The RMD will sit in your bank and be used to offset the difference in your take-home-pay over the course of the year.

You are still subject to RMD rules if you inherit a Roth IRA. However, the distributions from an inherited Roth are non-taxable. It is best to wait until the end of the year to take your RMD because distributions and growth are tax-free.

Lastly, do not forget to take your RMD if you are subject to one. The penalty tax for failure to distribute an RMD by the due date is 50% of the distribution. This is on top of the ordinary income tax that is required to be paid on the distribution. Make sure that you have some plan in place if you are subject to an RMD.

You should discuss these strategies with a professional tax advisor before implementing them to ensure they benefit your particular tax situation. Reach out to us if you would like to explore this tax planning strategy or ask any further questions.

 

Written by Garrett Gould

Garrett Gould is a remote financial planner who specializes in long-term tax management. He is the co-owner of Halyard Financial and advises individuals, families, and small business owners throughout the nation. Garrett is an Enrolled Agent with the IRS who has passed all three of the CFA exams and has been creating financial plans for several years. Garrett is located on the Upper West Side in New York City.

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