If you’ve been saving for years in a traditional IRA or a 401(k), you’ve benefited from the tax-deferred growth of your investments. But you’ll finally have to pay Uncle Sam when you take the money out — and the rules changed recently. The following strategies can help you minimize taxes, avoid penalties, and make smart decisions when you have to start taking IRA withdrawals.
- Make the most of the new rules for RMDs. Two recent tax laws made major changes to the RMD rules. In the past, you had to start taking withdrawals from your traditional IRAs and 401(k)s after you turned age 70 ½, based on the balance in your account at the end of the previous year and the IRS’s life-expectancy factor for your age. But the SECURE Act changed the rules — now you don’t need to start taking RMDs until you reach age 72, which provides more time for the money to grow tax-deferred in the account.
Meanwhile, the CARES Act (the Coronavirus Aid, Relief and Economic Security Act) changed the rules for everyone this year. Because of stock market volatility and economic challenges from the coronavirus, the RMD requirements are waived in 2020. You don’t need to take out any money from your accounts this year, regardless of your age.
Since you don’t need to take RMDs in 2020, one strategy is to convert some of the money from a traditional IRA to a Roth. You have to pay taxes on the conversion like you would with a traditional IRA withdrawal, but the money then grows tax-free in the Roth IRA after that. You never have to take RMDs from Roth IRAs, and having some money in a Roth can help diversify your tax situation — you’ll be able to tap the account tax-free in retirement, which can be particularly helpful if most of your retirement savings is in tax-deferred 401(k)s, traditional IRAs or a taxable pension. There are no income limits for making Roth conversions, even if you earn too much to make Roth IRA contributions.
You can convert money from a traditional IRA to a Roth at any age, but if you’re 72 or older, you usually have to take your RMD first (and pay taxes on that withdrawal) before you can convert money in the account to a Roth. Because you don’t have to take RMDs in 2020, this can be a good year to make a conversion and just pay that tax bill instead. - You have a lot more flexibility when taking required withdrawals from IRAs than you have for 401(k)s.
If you have several 401(k)s, you have to calculate the required withdrawal and take the money from each account separately. Your 401(k) administrator may let you sign up to withdraw money automatically every month or by a certain date every year, so you won’t need to worry about missing the RMD deadline.
The IRA rules are different. If you have several traditional IRAs, you calculate the required withdrawals from each account, but then you can add up the total RMDs from all of the accounts and can take the money from any one or more of your traditional IRAs (Roth IRAs do not have required distributions). You can choose, for example, to keep money growing in an IRA with low fees and better investing choices and tap a less-attractive IRA for your withdrawals first.
You can’t take 401(k) withdrawals from an IRA, and you and your spouse both need to calculate and withdraw your RMDs separately, even if you file a joint income-tax return.
- You can avoid the tax bill by giving your RMD to charity.
A great strategy for avoiding the tax bill on your RMDs is by making a “qualified charitable distribution” (QCD). After you turn age 70 ½, you can give up to $100,000 each year directly from your IRA to a charity, which counts as your RMD but isn’t included in your adjusted gross income. This move can be particularly helpful if you don’t itemize your income-tax deductions and wouldn’t get a tax break for your charitable gifts otherwise. Keeping your RMD out of your adjusted gross income can also help you avoid or minimize the Medicare high-income surcharge, if you were near the cut-off. (Even though the age for taking RMDs was increased to 72 by the SECURE Act, you can still make a QCD any time after you turn age 70 ½.)
You need to make the transfer directly from your IRA to one or more charities; you can’t withdraw the money first. Ask your IRA administrator for its procedure. - You can delay some – but not all — RMDs if you’re still working at age 72.
If you’re still working at age 72, you can delay taking RMDs from your current employer’s 401(k) until after you leave your job (unless you own more than 5% of the company). But you still need to take required withdrawals from your traditional IRAs and from former employers’ 401(k)s. You may be able to avoid some of these RMDs, however, if your current employer lets you roll money over from previous employers’ 401(k)s into your current plan. - Roth IRAs don’t have RMDs, but Roth 401(k)s do.
You don’t have to take RMDs from Roth IRAs, but you do have to take required distributions each year from Roth 401(k)s, even though the IRA withdrawals are not taxable. However, you may be able to avoid the RMDs if you can roll over the Roth 401(k) money into a Roth IRA. If you wait until age 72 to do the rollover, you usually need to take that year’s RMD first before you can roll over the remaining money (although there are no RMDs required in 2020).