Cash Flow from Avoided Required Minimum Distributions (RMDs): A Look at Potential Uses

Cash Flow from Avoided Required Minimum Distributions (RMDs): A Look at Potential Uses

As individuals reach the age of 73 (or 75 for those born in 1950 or later), they are legally required to take Required Minimum Distributions (RMDs) from most types of tax-deferred retirement accounts, such as IRAs, 401(k), or similar accounts. These taxable withdrawals are known as RMDs.

However, for those finding taking taxable withdrawals every year a burden, there's an option to consider: converting an ordinary IRA into a Roth IRA. While this move comes with a tax bill due immediately, it's important to note that Roth IRAs are not subject to RMDs.

The IRS determines the minimum amount of RMD based on the account holder's age, with the percentage increasing as the account holder ages. For instance, at the age of 73, the RMD percentage is approximately 3.77% of the account's value as of the end of the prior year.

When reinvesting an RMD, an in-kind transfer from an IRA to an ordinary brokerage account can be requested, providing a precise distribution value figure for the day the transfer was officially done.

It's crucial to note that each 401(k) account requires its own RMD, and the first RMD doesn't need to be completed until April 1 of the year after you turn 73, but subsequent RMDs must be completed by the end of the calendar tax year.

If you choose to convert your IRA into a Roth IRA to reduce RMDs, you'll want to convert as much money as possible as quickly as possible to keep the number of years you must take them to a minimum. Performing a Roth conversion over multiple years in tranches can help manage the tax bill, and using RMD money to cover this tax bill is an option.

However, it's essential to remember that you cannot mix and match withdrawals from different types of retirement accounts, like a 403(b) and a traditional IRA. Also, a Roth conversion does not satisfy the RMD for that year, and paying taxes on one does not negate the tax bill for the other.

On the other hand, if you are over 70 and a half, transferring cash or assets directly from your IRA to a charity can qualify as a qualified charitable distribution (QCD), allowing for tax-deductibility limits much higher than regular RMDs. The limit is $108,000 per individual or $216,000 for a married couple.

In terms of taxation, when you convert funds from a Traditional IRA to a Roth IRA, the converted amount is treated as ordinary income in that tax year and taxed accordingly. In contrast, RMDs are minimum amounts that you must withdraw annually beginning at age 73 or 75, and these withdrawals are taxable as ordinary income in the year taken.

Proper planning is essential to avoid unintended tax bracket increases and Medicare surcharges with Roth conversions, especially ensuring RMDs are taken before any conversions after age 73 or 75.

In summary, Roth IRA conversions create taxable income upfront with no future RMDs, allowing tax-free growth and withdrawals thereafter, while traditional IRA RMDs are mandatory taxable withdrawals that begin at a specific age and increase taxable income annually.

• Engaging in personal-finance planning is crucial for individuals approaching retirement age, as they are required to take RMDs from most retirement accounts, like IRAs and 401(k)s, which involve taxable withdrawals.
• One option to consider for those finding RMDs burdensome is converting an ordinary IRA into a Roth IRA, even though it incurs an immediate tax bill. Notably, Roth IRAs are exempt from RMDs.
• When deciding on a Roth conversion to reduce RMDs, it's wise to convert as much money as possible as quickly as possible, potentially using RMD money to cover the tax bill, given that Roth conversions create taxable income upfront while eliminating future RMDs.

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