5 Strategies to Take Control of Your Required Minimum Distributions (RMDs)

Taylor Schulte: 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 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.

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 IRMAA 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 5 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/221. 

In 1986, the Tax Reform Act introduced the concept of Required Minimum Distributions (RMDs), requiring account holders to begin withdrawals from their pre-tax retirement accounts once they reached age 70 ½. 

In 2019, over 30 years later, The Setting Every Community Up for Retirement Enhancement Act (aka the SECURE Act) increased the RMD age to 72. 

And then, most recently, in 2022, the SECURE Act 2.0 increased the RMD age to 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 to take 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 will 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 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 they cause and gain more control over this bucket of money, I’m going to share 5 proactive strategies for you to consider. 

The first two strategies are fairly well-known. I didn’t want to exclude them in case someone listening could benefit, but I’ll breeze through them quickly and then dig into the more unique ones.

The first is to consider proactive Roth conversions ahead of turning age 73. I’ve talked a 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 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. 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 and 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 you retire from work, and end when RMDs begin. They’re commonly referred to your “gap years” because there is a gap in income, and as a result, people often find themselves in the lowest tax bracket they’ve ever been in.

As you might already know, the amount of your Required Minimum Distribution is based on the value of your pre-tax retirement account and your age. 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 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 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 I’ve published in today’s show notes which can again be found by going to youstaywealthy.com/221.

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 non-profit organizations. Since the money is going to a qualified non-profit, the distribution is not taxed. And while RMDs don’t begin until age 73, you can actually start doing QCDs at age 70 ½, allowing you to start reducing your IRA balance a few years ahead of your first required distribution.

Perhaps the 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 would rather give it to a 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 the year you turn 73, 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, there is not a minimum QCD amount. Any amount you process as a QCD will reduce the amount of your requirement minimum distribution. For example, if you only give $5,000 through a QCD this year, then your RMD will be reduced to $35,000. 

Now, while there isn’t a minimum, there is a maximum of $105,000 per person per year, which will increase slightly each year because it is now indexed for inflation under the new Secure Act 2.0 rules. Since the maximum limit is per person, a married couple can each process a $105,000 QCD for a total of $210,000 as long as both you and your spouse 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.

A few other important things to know before we move on:

1. QCDs cannot be processed from employer plans like 401ks and 403b’s – they can only be made from Traditional IRAs, Inherited IRAs, and inactive SIMPLE and SEP IRAs. They must also be directed to a qualified non-profit, so be sure to check with your advisor or custodian before doing anything. 

2. You cannot make a QCD to a donor-advised fund or private foundation. You also cannot benefit from the 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. 

3. 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. 

4. Lastly, the Secure Act 2.0 provided a unique opportunity to use a QCD to fund a Charitable Remainder UniTrust (CRUT), Charitable Remainder Annuity Trust (CRAT), or Charitable Gift Annuity (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. 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. 

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 tax-smart way to meet your charitable giving goals later on in life with those pre-tax dollars 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 included in your taxable income. 

In other words, your custodian (Fidelity, Schwab, Vanguard, etc.) will not indicate that the distribution was a QCD, that’s on you to report the activity properly to avoid getting hit with taxes or penalties. So if you process a Qualified Charitable Distribution in retirement, it’s important that your financial advisor and accountant are notified of this transaction to ensure it’s reported to the IRS correctly and you don’t get stuck with a tax bill on a charitable donation. 

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

The reason I bring this up is that many 401k plans allow participants to transfer (or roll) external pre-tax IRA dollars into the plan. So, if you have a pre-tax IRA that is exposing you to RMDs in the near 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 that you are 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 you’re 73 years old and have a total of $1 million in your pre-tax account bucket. If you retired now, your first RMD would be about $40,000. But if you kept working and 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 will be closer to $125,000 – more than 3x the original amount. 

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

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.  

Ok, the fourth strategy to share with you today helps retirement savers a little differently. Instead of reducing your tax bill or reducing your RMDs, this strategy can help you reduce the risk of your investments and/or better match your long-term goals with your investment plan.

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 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, etc.) and financial advisor will provide the updated amount to you each year and send several reminders to ensure you don’t forget to take your mandatory withdrawal. 

Again, all the IRS cares is that the minimum amount is withdrawn, allowing them to collect their share of the taxes you have been deferring for decades. You can certainly withdraw more than the minimum if wanted or needed, but doing so will only 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 are a doomsday prepper with an all-cash portfolio, processing the withdrawal each year will naturally require you to sell one more securities in your account.

To keep it simple, let’s say you have four investments in your pre-tax IRA – a money market fund (i.e., cash), a U.S. 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 U.S. stock fund, allowing you to take some of the gains off the table (i.e., sell high) and reduce concentration risk in that asset class. 

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 mange investment risk during your RMD years. 

For example, maybe instead of four broad-based investment funds, you own something closer to eight or ten – perhaps instead of just owning one U.S. 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 an 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 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 you own, reducing your concentration risk and locking in some of those gains.

A simplified approach to following this strategy is to just 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 of your rebalance in order to process that year’s RMD. 

While it still requires some number crunching or access to a portfolio rebalancing tool, this approach takes the guesswork out of everything and 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 of cash you need 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. 

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, most people are likely ok 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:

1. 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 RMD – they’re all lumped together in the IRS’s mind. So, for example, if you have 3 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 if desired. 

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 in the last decade is your simplified way of taking chips off the table and reducing risk. Or, maybe you are 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 401k’s…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.

2. 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 to avoid any processing hiccups causing an RMD to get missed. 

While taking your RMD in November or December instead of in January or February is the textbook answer, the extra little time your money has to grow tax-deferred likely won’t make a huge dent in your long-term success. 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 and your budget, then do it. This is not a decision that will make or break your plan. 

Okay, the last strategy to discuss is something I touched on in a past episode, but based on many of the conversations I’ve had 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 Long Term Care expenses in retirement. 

This strategy essentially takes advantage of the often overlooked Medical Expense Deduction, or IRS Publication 502. In short, medical expenses, including LTC 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, 

“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, “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 costs 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 allows the client to keep the money invested – perhaps invest it a little 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 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 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. We’re just creating a bucket (if you will) that is 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 co-mingled and we can sleep at night knowing that there is 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 the 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 7.5% of your adjusted gross income (or AGI). So, if your AGI is $100,000, 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 example, let’s say 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 deduce the full $100,000, you were still able to get funds out of your pre-tax IRA at a very favorable rate.

Going full circle 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 long-term care isn’t 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 are not needed or wanted. 

Now, you might be thinking, this is great, Taylor, but it doesn’t really give me control of 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. 

I get it, and that’s very true, but I would still argue that you are making proactive planning decisions about things that you do have control over. And by making those decisions intelligently in advance, you are improving your overall plan, reducing risk, and staying focused on things 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 of catastrophic risks that could destroy our financial 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 is ultimately implemented combats the risk of a catastrophic long-term care event while also mitigating taxes and reducing unwanted mandatory distributions, 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 conversion is that they are worried they won’t be able to tax-efficiently convert all of their pre-tax dollars before RMDs begin. 

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 onto 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. 

Really quick, before we wrap up, you might have caught me saying earlier 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 has one, or 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 the situation, you can deduct those eligible medical expenses that are incurred on your tax return and apply the same concepts I’ve discussed here today.

We went through a lot today, so let’s quickly recap the 5 ways to gain more control over your RMDs:

1. Roth conversions during your gap years
2. Qualified Charitable Distributions or QCDs
3. Rolling pre-tax IRA dollars into a 401k if still working
4. Withdrawing RMDs from the most appropriate asset classes
5. Earmarking pre-tax IRA dollars for a potential 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/221.

Thank you, as always, for listening and I will see you back here next week.

Episode Disclaimer: 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.