SmartAsset and Yahoo Finance LLC may earn commission or income through links in the content below.
I am soon to be 68 and plan to wait to claim my Social Security until I am 70 to maximize my monthly benefit. I also plan to retire at the end of the year, if not sooner (in three months or less). Does withdrawing from traditional IRAs (current balance is $215,000) to reduce income tax on my RMDs outweigh the benefits of investing those expenses and growing them tax-deferred? My understanding is that if I take out my standard deduction, those amounts will be tax free.
– Austen
Retirement, Social Security benefits, required minimum distributions (RMDs), taxes… there are a lot of moving parts to making decisions about your retirement income. Reducing the amount of money you take toward RMDs can help reduce your taxes once you take them. This can help avoid taxes on Social Security benefits.
If you don’t need the money now, but want to reduce RMDs later, one of the best moves may be to convert a portion of your IRA to a Roth IRA each year. That can help reduce the funds required in the future and help your money grow tax-free, although there may be tax consequences for certain funds. (A Financial advisor (It can guide you through the Roth conversion process and avoid unwanted tax consequences.)
Delaying Social Security benefits until age 70 makes sense for some people. That’s when you can receive the largest monthly payment. You can start collecting Social Security retirement benefits at age 62, but your monthly amount will be reduced by 30 percent.
For example, if your full retirement benefit is $2,000, your payment at age 62 will be only $1,400. However, waiting until age 70 gives you a maximum monthly benefit of $2,480.
Still, there are some situations where it may be more beneficial to start early, such as:
• You need the money to make ends meet • You are in poor health or short lived. • You are completely done • Your spouse earns a higher income and defers benefits
Remember, there is no right answer that works for everyone, and you should do what’s best for your family. (And if you need help planning for Social Security, Consider working with a financial advisor.)
Required minimum distributions (RMDs) trigger income taxes and can put you in a higher tax bracket.
Once you turn 73, you must begin taking required minimum distributions—known as “RMDs”—from all of your traditional retirement accounts, including IRAs and 401(k)s. Your RMD is calculated based on the IRS’s uniform life expectancy table, based on your age, maturity and account balance. If you have multiple IRAs, you’ll need to figure out RMDs for each one separately.
What happens if you don’t take an RMD? The IRS will charge you a penalty tax of 50% of the amount it should have taken. If you make the correction and take the RMD within two years, the tax rate may drop to 25% or 10%, depending on the situation. (If you need help calculating your RMDs, Consider matching with a financial advisor.)
When you withdraw money from a pre-tax retirement account like a traditional IRA, you pay income tax on that withdrawal. Once you’re past 59.5, it won’t hit you. 10% early withdrawal penaltyBut the money will be part of your taxable income.
In theory, if your total taxable income including IRA withdrawals doesn’t exceed yours Normal reductionThey do not pay income tax. The correct answer depends on your full tax situation, which can change from year to year.
There are a few things you can do now to reduce future RMDs and future tax bills.
One option is to withdraw money from your IRA now to reduce the balance and reduce your future RMDs. That would increase benefits and make it easier to wait until age 70 to start receiving Social Security. On the flip side, you lose more tax-deferred growth in your IRA and have a smaller nest egg to pull from later.
You can also transfer some or all of your IRA to a Roth IRA. You pay tax on the converted amount just as you would if you took the money out. But your money continues to grow tax-free in a Roth account, which is not subject to RMDs. As an added bonus, Roth funds are not considered taxable income, so they are not affected by taxes on Social Security benefits. One caveat: Roth IRA conversions come with a strict five-year rule. To maintain full tax-free status, you can’t withdraw cash at all for at least five years from the time you convert.
Finally, if you don’t want the money from your IRA, you can donate your RMD directly to an eligible charity. Qualified charitable distributions (QCDs) This direct donation completely bypasses taxable income. If you’re going to make a donation, here’s how you can do it. (If you have additional questions about your future tax liability, Consider talking to a financial advisor.)
A person calculates how much his RMDs will be for the current tax year.
There are things you can do now to reduce your future RMDs, but each strategy will have a different impact on your overall financial picture. You might consider withdrawing money from an IRA, converting an IRA to a Roth account, or donating an RMD to charity, eliminating your tax bill on the money in the process. Keep in mind that the option you choose may affect taxes on your Social Security benefits.
A Financial advisor It can help you plan for RMDs and make other important decisions for retirement. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s Free tool It matches you with up to three vetted financial advisors in your area, and you can interview your advisor at no cost to decide which one is right for you. If you’re ready to find an advisor to help you achieve your financial goals, Start now.
Consider a few consultants before settling on one. It’s important to make sure you have someone you trust managing your money. When considering your options, These are the questions you should ask a counselor. To make sure you make the right choice.
Keep an emergency fund handy in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to high volatility, like the stock market. The trade-off is because the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
Are you looking for a financial advisor to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so they can spend more time converting. Learn more about SmartAsset AMP.
Michelle Kagan, CPASmartAsset’s financial planning columnist answers reader questions on personal finance and tax topics. Have a question you want answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Michelle is not a participant in the SmartAsset AMP forum, nor is she an employee of SmartAsset, and was compensated for this article.
