If you’re looking to invest in tax-advantaged accounts, it is important to know that you will be forced by the government to begin withdrawing funds once you reach age 70 1/2.
The required minimum distribution depends on multiple factors, including the amount within the account and overall age. Helpfully, there are worksheets to help you figure out the required minimum distribution for your accounts, which is important to know when it comes to budgeting and planning for taxes.
Often, these minimum requirements force people to take more money out of their accounts than they would like. However, should you fail to follow the rules, a 50 percent penalty will be placed on the amount that should have been withdrawn, so it is important to make sure that enough funds are being taken out each year.
Rather than avoiding withdrawals, you can take steps to reduce your required minimum distributions, such as the following:
1. Invest in a Roth IRA.
Only traditional IRAs are subject to required minimum distributions, as the government expects a certain amount of taxes to be paid. Because you pay the taxes on a Roth IRA upfront and then make tax-free withdrawals, these accounts do not have the same requirements, which makes them a great option for saving for retirement.
You should know that a Roth 401(k) does have required minimum distributions despite being funded in a similar way to Roth IRAs. However, you can roll a Roth 401(k) into a Roth IRA to avoid this issue.
Roth IRAs do not always make sense for everyone. Generally, individuals who believe that they will be in the same or perhaps a lower tax bracket now than when they retire should consider this sort of account. People who will be in a lower tax bracket once they retire benefit more from tax-deferred accounts. It is an important balancing act deciding between these two types of accounts. Individuals typically lose a smaller percentage of their income by taking minimum distributions than if they used a Roth IRA as a primary account.
2. Take early distributions.
When you withdraw money from your retirement accounts prior to the age of 70 1/2, you will have a lower overall account balance, which means that the required minimum distribution will go down.
Prior to the age of required distributions, you can withdraw at your own pace, so it is fine to take larger chunks, or even smaller chunks, during this time period. Doing this provides greater control over how much you pay in taxes in a given year, as you can keep yourself in a lower tax bracket.
If you notice that you are approaching the top of a tax bracket, you can avoid surpassing that number by relying on pre-taxed sources of income, such as a Roth account, to get through the remainder of the year. In addition, it is possible to convert some of the tax-deferred income into a Roth account to keep this option open for the future.
3. Open an HSA.
A health savings accounts (HSA) is not always considered a retirement account, but it can be one of the best places for saving some cash. Contributions to an HSA reduce taxable income in a given year and, provided that you use the money for qualified health expenses, you will not pay taxes on it, even upon withdrawal.
Money from an HSA can go toward a variety of medical expenses, from provider bills to health products. You can also use the money for non-medical purposes, although you will need to pay taxes in this case, and if you are under the age of 65, you will incur a 20 percent penalty.
In many ways, an HSA resembles a traditional IRA with some added benefits. You invest the money in the account and let it grow over time. However, there are no required minimum distributions put on these accounts, so you can leave the money in it indefinitely.
At the same time, only certain people can open and contribute to an HSA, including those with a high-deductible health insurance plan, meaning a deductible of at least $1,400 for an individual or $2,800 for a family.
4. Keep working longer.
If you continue to work past the age of 70 1/2, you do not need to take required minimum contributions from your retirement accounts (provided that you do not own more than 5 percent of the company where you work). In this case, required minimum distributions kick in once you retire.
Importantly, the minimum may be quite high at this point since the balance in these accounts is likely to be higher after additional years spent working, although that is not the case if you have used the funds.
Working does not stall minimum required distributions from all accounts. If you have a traditional, SIMPLE, or SEP IRA, you will need to take money from your accounts even if you meet the criteria listed above. If you do not have an IRA or only have a Roth IRA, you will not need to worry about any required distributions.
5. Donate distributions to charity.
You can also reduce your tax bill by contributing required minimum distributions to charitable causes. The IRS currently allows up to $100,000 in charitable donations from an IRA each year. When you donate to a qualifying tax-exempt organization, your donations are tax deductible, which can help lessen a tax burden.
Importantly, you should always keep records of the donation, whether that is a credit card or banking statement, along with a signed acknowledgment from the organization itself. This paperwork does not need to be submitted with taxes, but it could become important in the event of an audit.