If you have unneeded cash from required minimum distributions (RMDs) from tax-deferred accounts like IRAs or 401(k)s, you may consider reinvesting that money in a Roth IRA. Roth accounts allow for tax-free withdrawals, including gains on investments, and do not require RMDs during your lifetime. However, there are restrictions on converting RMDs directly to a Roth. One potential workaround is to contribute to a Roth IRA, with a maximum contribution of $7,000 (or $8,000 for those over 50) for 2024, if you have earned income.
The IRS defines earned income as money received for work, such as wages, commissions, and self-employment income. Income that does not qualify includes pension payments, interest, dividends, and withdrawals from Roth IRAs. There are also income limits for Roth contributions, with phase-out ranges based on modified adjusted gross income (MAGI). Additionally, a five-year waiting period is required for withdrawals from a Roth account, and heirs may need to withdraw the balance within 10 years. It may be helpful to consult a financial advisor to develop a tax-efficient retirement strategy.
If you do not qualify to make Roth contributions, there are other options to reduce, eliminate, or delay RMDs. These options include Roth conversions, Qualified Charitable Distributions, and continuing to work to delay RMDs for 401(k) accounts with current employers. It is important to follow the rules regarding RMDs, as failing to take them on time can result in penalties of up to 50% of the missed amount. A financial advisor can offer guidance on navigating risks and tradeoffs in your specific situation.
Reducing your tax burden in retirement involves looking at all sources of income, including retirement accounts, RMDs, Social Security benefits, and taxable investment income. By strategically withdrawing from IRAs early in retirement, delaying Social Security benefits, and coordinating taxes and withdrawals between spouses, retirees can minimize taxes. Other tax-saving strategies include investing in tax-free bonds, moving to tax-friendly states, harvesting tax losses, and qualifying for lower capital gains tax rates. Consulting a financial advisor can offer valuable insights on retirement planning.
Managing RMDs and navigating complex tax issues in retirement can be challenging. Estimating retirement taxes before collecting pensions, Social Security, and retirement account withdrawals is crucial. A financial advisor can help structure and coordinate payments throughout retirement to optimize tax efficiency. SmartAsset’s free tool can match you with up to three vetted financial advisors to help you make informed decisions about retirement planning and tax management. Ensure your cash reserves are protected from inflation by securing them in accounts with competitive interest rates to preserve purchasing power over time.
