Every Silver Lining has a Cloud

March 21, 2024

The surging stock market as 2023 came to a close pushed the value of many retirement accounts to new highs. There is no such thing as having “too much” money for retirement.

However, for those who are taking Required Minimum Distributions (RMDs) from their accounts, there are tax considerations to keep in mind. As one ages, RMDs get larger as a percentage of the account, because one’s life expectancy gets shorter. Couple that with a boost in the account value, and the RMD could be much larger than expected in 2024.

Having extra income is welcome, of course, but there are tax considerations to keep in mind. The extra cash distribution could push the retiree into a higher tax bracket. It may trigger surcharges on future Medicare premiums, and it could increase the income tax on Social Security benefits. In some cases the 3.8% surtax on net investment income could be triggered. That applies when modified adjusted gross income (basically adjusted gross income plus any tax-free income from municipal bonds) is larger than $200,000 for single people or $250,000 for married couples. Those thresholds are not inflation adjusted.

Financial planners offer three strategies for reducing taxes on RMDs.

Keep working. RMDs are required from 401(k) plans, unless the plan participant is still working for the employer. In that situation, RMDs can be delayed until retirement and separation from service, which can happen at any age. However, note that this rule does not apply to 5% owners of the employer. Delaying RMDs will make them still bigger when they finally do begin. Note also that this rule does not apply to any traditional IRAs that the participant may have—RMDs from those must begin the year the owner turns 73.

Qualified charitable distributions (QCDs). Those who are 70 ½ are permitted to direct their IRA custodian to make a contribution to a qualified charity. The maximum amount per taxpayer is $105,000 in 2024, as the threshold is now indexed for inflation. A QCD counts as a required minimum distribution, but it does not get added to taxable income, so the tax troubles mentioned above are avoided.

A married couple could each have a QCD of up to $105,000, but only if they each have their own IRA.

Convert the IRA to a Roth IRA. Unlike the traditional IRA, there are no RMDs with the Roth IRA. What’s more, the Roth IRA distributions are generally tax free, and so do not create additional tax problems. However, an income tax must be paid on the entire amount of the conversion to a Roth IRA, and that can be a lot to handle in a single year. Hence, it may be better to do the Roth conversion gradually, over a period of years. A down market is a good time for a conversion, as the tax cost will be lower.

RMDs during retirement cannot be converted to Roth IRAs, but conversion of IRA withdrawals in excess of the RMD is permitted.

Looking ahead, the wider tax brackets and lower top rates enacted in 2017 are scheduled to expire after 2025. It may make sense to take advantage of those lower brackets while they remain available this year and next.

(January 2024)

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Legal, Investment and Tax Notice: This information is not intended to be and should not be treated as legal advice or tax advice. Readers should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel.