3 RMD Strategies to Reduce Your Tax Burden

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Peter, it's really good to see you today. We are talking about three RMD strategies to reduce your tax burden. I know that you're always thinking of those strategies to help your clients reduce their taxes. So we want to talk about those required minimum distributions because proper planning is vitally important.

So first, what are RMDs and how are they calculated? So RMDs are essentially the minimum payment on your yet-to-be-realized tax liability. In other words, it's a minimum payment on your tax bill, right? Just like you've got a minimum payment on your mortgage or a minimum payment on your credit card, you've got a debt to the IRS inside of your tax-deferred accounts. And if you don't really believe that it is a debt, just wait until 72 when they start requiring minimum payments on that debt.

It will feel very similar. What they do is they require that you start to take a withdrawal from your IRAs at that point in time to pay them the yet-to-be-realized tax bill that lies within that account. So you look at that balance inside of your 401k and an IRA and you say, wow, I've got a million dollars for retirement. But unfortunately, we don't have that full amount because part of that money is yours, a good portion of it. But part of it, also a pretty significant portion, belongs to the IRS and you just haven't paid it yet. And starting under current law at 72, they begin mandating, forcing that we take distributions so that that income is taxable so that they can begin to realize that tax liability in that bill.

Yeah, you knew they'd come for their money. So I know that you also work really hard to make sure that your clients take those distributions when they need to, because if they don't, there is a very significant penalty. Yeah, in fact, it is the largest personal penalty that the IRS levies. It is a 50% penalty on what you were supposed to distribute. And the RMD amount goes up as far as a percentage of the total account balance every year. But let's just say we've got a million dollar 401k or IRA balance and the first year's RMD is about $40,000 or so, based on a percentage of that total account balance. Well, if you don't take it, that 50% penalty, it would be $20,000 just in penalty. Plus, you still owe tax on the entire amount.

So you'd have taxes on $40,000 and $20,000 would go away in the form of the penalty. So this is one that you don't want to miss. Often, Erin, we are doing this closer to the end of the year, just a double check and a review to make sure that everybody has taken it. But looking at 2023, it may be advantageous to be a little bit more proactive and possibly take your RMDs closer to the beginning of the year. Okay, well, I'm glad you bring that up because I do want to talk on three strategies to reduce the tax burden that comes with RMDs. And something that you had mentioned was consider taking early distributions.

Why is that? Yeah, now this does not qualify as an RMD, technically, because the RMDs, the R is the required part, the requirement does not begin until 72. But if we can decrease our tax deferred balances in retirement accounts, then we will have less RMD once we get to that stage. So we could start taking distributions from those accounts as early as 59 and a half. And in fact, you could even begin to control that total balance well before that with Roth conversions. I think we're going to talk about that specifically in strategy number two.

But reducing your total tax deferred balance, whether by taking distributions as early as 59 and a half, or by other means or methods is going to then later reduce the total balance that your RMD is calculated from. Right. Okay, so let's talk about those Roth conversions, which is something that we've talked about at length before, Peter.

Yeah, absolutely. And it's something that we do a lot of discussing and planning for here in the offices of Rashan, planning for our clients. This is one of, I think, our best opportunities to control our lifetime tax liability.

It's not what you have, it's what you get to keep. And we've got to plan proactively to keep as much of our money as possible. Now, Roth conversions are going to be a taxable event. So there are a lot of considerations that go into Roth conversions. What is your tax rate and bracket now compared to what do we expect and anticipate our tax rate and bracket to be into the future? But a lot of times people are under some perception that they are going to significantly drop tax brackets in retirement. And when we really look at what lifestyle costs, what they're used to and accustomed to spending, we find that those tax brackets and rates, they're actually pretty wide and their anticipated retirement income puts them in the same tax bracket. So we may want to consider those Roth conversions early. But we do need to compare and we can sort of estimate to the best of our ability what the tax rates and brackets might be, are likely to be into the future. We don't necessarily know with certainty, but here's where the real advantage of that Roth conversion comes in.

It's just one man's humble opinion, but it's shared by many, many, many that I talk to. I think that tax rates might go up into the future. If they do, paying that bill now will be a cost saving effort. If everything is kept in a vacuum and tax rates and brackets and income is exactly the same into the future, at worst, it is a wash to do those Roth conversions. So again, we'll crunch the numbers, we'll take a look at specifics on a case by case basis. But Roth conversions are a great way to start as young as you are today in controlling your lifetime tax liability. Right.

Okay. And the third strategy here that we wanted to talk about, qualified charitable distributions. And Peter, this along with Roth conversions, they're important and complicated. We've actually done two separate breakout videos on these. Yes, we have.

And if you've got questions, you can go back and watch those videos or you can give us a call. But qualified charitable distributions or QCDs, because we all love those short acronyms, are one of the very few opportunities that we have for truly tax free money over the course of our lifetime. And that's because the RMD actually skips us and goes straight to a charity. So you could sort of look at it as a wash. We're taking a distribution from our IRA on one hand, but we're also making a donation of the same amount directly to a charity. In the case of the QCD, it has no net effect on our income. It satisfies the RMD.

That's the most important part. So you don't have to worry about the 10 percent or rather the 50 percent penalty. And it also does not create a taxable event at all that that impacts your tax returns and income tax bill. So the QCD, the qualified charitable distribution, a great opportunity.

Your charity, your church, your organization gets the benefit of the full amount of the gift that you give. You satisfy your RMDs and you have no net effect on your tax returns and tax bill. And by the way, Aaron, while the age for RMDs is 72, the government changed the law and pushed that age back. The original age was 70 and a half, and they actually did not change the 70 and a half age for QCDs. So even if you're not technically quite yet required to take that distribution, you can still take advantage at 70 and a half of the ability for the qualified charitable distribution, the QCD.

That's great. A great consideration because it's a win win for everybody. So again, this just all comes back to strategic tax planning because RMDs are considered income. And then it goes back to what you were just mentioning earlier, Peter, a common misconception that we will be in a lower tax bracket when we retire.

I call it the gross planning mistake. You look at your balance, whatever the 401k and IRA balances, and you say, oh, I've got this much money for retirement. Well, that's your gross number. But don't forget that taxes stand between you and actually spending that money.

So you only get to spend your net. And unfortunately, a lot of people forget to factor that in or really minimize what impact that is going to have. There is nowhere written in stone nor in the tax code that we pay less tax in retirement. And in fact, the way that our retirement savings has been set up for really the last 35, 40 years, the last generation, many retirees have set themselves up for paying the most tax possible in retirement rather than controlling and reducing their tax liability.

So not that we did anything wrong because taxes have come down over that period of time. But now is the time to change our paradigm and way of thinking and looking at tax planning for the future, whether it be for your lifetime or for a legacy for loved ones and family and beneficiaries. Planning for taxes is important. You want to keep as much of your money as possible. And most people don't want to leave the IRS as their largest beneficiary either.

Yes, no, that is not your patriotic duty, that's for sure. Peter, this was incredibly helpful. Again, some of these strategies are a little bit more complicated. So if somebody has questions, what's the best way to reach you? Yeah, we'd love to help you work through them and in fact quantify how much it would cost you to implement some of these strategies and do a comparison on how much it's going to cost you if you don't, right?

We can look at those numbers side by side and then make an informed decision on whether or not this is going to be beneficial, any of these strategies would be beneficial for you. Give us a call at Rashan Planning 919-300-5886, 919-358-86, or you can email info at rashanplanning.com or get in touch with us through the website, rashanplanning.com. It looks like richonplanning.com.

All right, Peter, thank you. This has been Planning Matters Radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to seek investment, tax, or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss principle. Advisory services offered through Brooks' Own Capital Management, a registered investment advisor. Reduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management while insurance products pay a commission which may result in a conflict of interest regarding compensation.