Retirement presents a unique set of challenges that most people only experience once in their lifetimes. We’re moving from our working years - where we’ve become accustomed to cash flow that is derived from our employers or businesses - to a phase where we’re now responsible for replacing that cash flow with the various sources available to us in retirement.
One of the more challenging and confusing aspects of that is understanding the rules around required minimum distributions (RMDs) and how they impact your overall financial plan. Being intentional about how and when to take those withdrawals can have a major influence on how far your money goes in retirement. Here are some key planning considerations that can help you avoid common retirement tax mistakes and make smarter decisions about required minimum distributions.
What Is a Required Minimum Distribution (RMD)?
For investors who have accumulated tax-deferred assets such as traditional IRAs, SEP/SIMPLE IRAs, and most (non-Roth) employer-sponsored retirement plans, they have enjoyed the benefit of a tax deduction for saving in those vehicles as well as tax-deferred income and growth on those investments. While that motivates people to save in their working years, the government does require that we pay taxes on that money eventually. To do that, the IRS has implemented a rule requiring investors (upon reaching a specified age) to withdraw a certain percentage of their account balance and pay ordinary income tax rates on those distributions.
When Do Required Minimum Distributions Begin?
The age requirement is updated from time to time, but currently, investors turning 73 in 2026 will need to make withdrawals from their tax-deferred accounts. Depending on your birthdate, that may be as late as 75 under current IRS rules. It’s also important to be aware that the percentage of the account that must be withdrawn increases every single year - so while the amount may be reasonably manageable in the beginning, those increases can start to build like a rolling snowball over time.
How Can RMDs Affect Your Taxes in Retirement?
Without proper planning, some investors may face challenges by painting themselves into a corner that could potentially limit their future options. Social security and pension incomes have usually kicked in by age 70, so expected incomes are forecast to rise from that point forward. As a result, in the year when an investor needs to start taking withdrawals, they can sometimes be forced into a higher tax bracket – and worse, might not see a better tax bracket again for the rest of their lifetimes.
This can become even more problematic for married couples when one spouse passes away before the other. If the surviving spouse inherits all tax-deferred assets, the required minimum distribution will not decrease, but their tax bracket may increase significantly once they are required to file as a single filer.
So, what can we do to mitigate those factors?
Unfortunately, there’s no way to completely avoid required distributions once they kick in. That said, there are several ways investors can plan ahead and reduce the overall tax bite from investing in tax-deferred accounts:
Consider overall cash flow needs
Are the required distributions a necessary part of your retirement plan, or will they be excess cash flow that won’t be needed for your own personal use? Answering questions like this is important when deciding how to optimize your RMDs. Naturally, you want to make sure that your current spending needs are covered. For many investors, however, that becomes more of a concern in their later years when inflation or increasing health care costs start to take a toll on social security and pension payments.
Forecasting how much income is needed - and when - can help optimize your cash flow strategy, especially since these factors may push investors into a higher tax bracket and/or increase the amount you’ll have to pay for your social security premiums. Understanding the path of cash flows over your lifetime can help identify potential pain points that might sneak up on you if you haven’t planned appropriately.
Should I replace income from my IRA or make Roth conversions before age 73?
Sometimes, it can make sense to withdraw from an IRA before the IRS forces us to, taking advantage of a (relatively) lower current tax bracket and heading off increases that we can see looming on the horizon. Roth conversions – a process in which we withdraw money from an IRA, pay taxes on the amount withdrawn, and then roll the proceeds into a Roth account – can be a great strategy for investors that don’t need access to that money right away. This reduces the overall balance that we have in tax-deferred assets, and therefore the amounts that will need to be withdrawn in later years. Once we have an accurate assessment of future cash flow needs, it will help to clarify whether realizing some taxes now in favor of reducing future taxes is a smart move.
How does the timing of retirement play a role?
Timing can be a major factor in your retirement planning. If an investor retires at age 65, we will have several years until required distributions kick in. If income drops significantly in the period immediately following retirement, this can be a fantastic time to consider withdrawing from tax-deferred accounts or performing Roth conversions if the money isn’t needed for immediate use.
This can be especially important for married couples with a significant difference in life expectancy. One of our favorite planning strategies is to model what happens to tax brackets in these scenarios and use distribution planning as a hedge against what could become a substantial increase in the surviving spouse’s tax bill. While we hope to never need this strategy, it can give confidence to the couple that the death of their spouse won’t come along with a pinch from the IRS.
Who will inherit the accounts?
If an investor determines that they have the opportunity to pull income forward to take advantage of expected tax rate changes, that doesn’t always make it the best move.
Inheriting tax-deferred assets can be tricky, and it’s important to understand the ultimate destination of those assets before deciding that it’s worth taking the tax hit now. While this strategy may be effective for beneficiaries that have a similar or higher tax bracket, it can backfire if the intended recipients are in very low tax brackets.
What if we plan on donating most or all of the money?
If that’s the case, it might not make sense to pull income forward and pay the taxes now.
We have come across investors that were advised to make Roth contributions, only to indicate that most of the money will probably be inherited by charities – all of whom won’t pay taxes at all when they eventually receive the funds. Additionally, if you have other options – such as Roth IRAs or brokerage accounts – it could be more effective to fund your own retirement with those sources and leave the tax-deferred accounts to charity.
Balancing how much money is needed for you and your family with how much you plan to give away can help minimize taxes, especially if you’re charitably inclined.
Consider whether charitable giving now can mitigate the tax bite.
Do you donate to your church, favorite organization, or the local animal shelter? With the updated tax codes in 2017, many investors lost the ability to itemize – and therefore, lost the ability to write donations off their tax returns. One of our favorite tools to counter this is by using qualified charitable distributions – essentially, donating directly from your IRA to the qualified charity of your choice. These donations count toward any required distributions for the year and have the added benefit of effectively bypassing your income tax return. Currently, the IRS allows up to $108,000 per year to be donated in this manner.
Planning ahead can also help you to make the best use of this rule. While RMD ages have increased recently to age 73, many investors are unaware that the age to make qualified charitable distributions did not – meaning, once you attain age 70.5, you can start making these donations and begin reducing the assets in your tax-deferred accounts before you start feeling the tax bite. If you expect to have more assets than you personally need, or may be subject to high tax rates later in life, qualified charitable distributions can be a great way to get funds out of these accounts before those taxes kick in.
Required minimum distributions are just one piece of a much larger retirement income strategy. The decisions you make about withdrawals, Roth conversions, charitable giving, and legacy planning can have a substantial impact on your lifetime tax bill and the amount of wealth you ultimately preserve for your family or favorite causes. Creating a personalized roadmap can help you stay flexible as your life, goals, and tax laws evolve.
Wondering how RMDs fit into your retirement plan? At AimWell Financial, we help retirees and pre-retirees evaluate withdrawal strategies, identify tax planning opportunities, and make informed decisions about their financial future. If you'd like a second opinion on your retirement income strategy, we'd be happy to start a conversation.