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Are RMDs Really the Tax Bomb You Think They Are?
If you’ve done any research on retirement planning, you’ve probably heard about Required Minimum Distributions (RMDs)—the mandatory withdrawals from pre-tax retirement accounts like IRAs, 401(k)s, 403(b)s, and Thrift Savings Plans. These withdrawals start at age 73 or 75, depending on your birth year, and allow the IRS to finally collect taxes on your savings.
Many people fear that RMDs will create huge tax burdens, potentially pushing them into higher tax brackets, making Social Security taxable, and even triggering Medicare surcharges. While this can happen in certain cases, RMDs might not be as devastating as you think. In fact, for many retirees, they’re a non-issue.
Let’s break it down.
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Each year, your RMD is determined by taking your retirement account balance as of December 31 of the previous year and dividing it by a life expectancy factor set by the IRS. In your first year of RMDs, this percentage starts at just under 4% of your account balance and gradually increases over time.
This means that if you have $500,000 in an IRA, your first RMD will be approximately $19,230. While that may sound like a lot, if you were planning to withdraw money anyway to cover expenses, your RMD might not make much of a difference in your tax situation.
Let’s compare two scenarios:
By age 73, their IRA balance will be around $631,000, and their first-year RMD will be $23,833—an amount they likely would have withdrawn anyway. In this case, RMDs aren’t a big deal because the retiree is already taking out the money naturally.
By age 73, their IRA has grown to $2.9 million, and their first RMD is over $109,000—far more than they would have withdrawn otherwise. This pushes them into a higher tax bracket and could cause Medicare surcharges and taxation on Social Security benefits.
For this person, RMDs are a real concern, and strategies like Roth conversions or strategic withdrawals may be beneficial.
If you’re worried about RMDs, here are a few ways to manage them effectively:
Many retirees rush to convert their traditional retirement accounts to Roth IRAs to avoid RMDs altogether. However, Roth conversions create immediate taxable income, and in some cases, the upfront tax cost may outweigh the long-term benefits.
The key is to convert strategically, filling up lower tax brackets rather than pushing yourself into higher ones.
If you’re charitably inclined, you can donate your RMDs directly to a qualified charity starting at age 70½. This lowers your taxable income and fulfills your RMD obligation without increasing your tax bill.
Many retirees face long-term care and medical costs, which can be deducted from taxable income. If you have large medical expenses, they may help neutralize the tax impact of your RMDs. Talk to a tax advisor to explore this option.
For some retirees—especially those with large pre-tax balances—RMDs can create tax headaches. However, if you’re already withdrawing money to cover living expenses, RMDs may not change your tax situation much.
Instead of assuming RMDs are a “ticking tax bomb,” take the time to evaluate your specific situation and consider strategies to minimize taxes efficiently.
If you’d like more insights, check out my video on 4 reasons why Roth conversions may not be right for you.
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