Alternatives to RMDs from Retirement Plans
Under SECURE 2.0, the Internal Revenue Service requires annual withdrawals from certain retirement accounts once you reach your Required Minimum Distribution (RMD) age. For individuals born between 1951 and 1959, RMDs generally begin at age 73, while those born in 1960 or later generally begin at age 75. While RMDs create taxable income, they can also present planning opportunities. At Truepoint, we work with clients to evaluate the available alternatives to RMDs and determine the approach that best aligns with their tax situation, cash flow needs, and long-term goals
There is no one-size-fits-all approach to managing an RMD. The most appropriate strategy depends on factors such as spending needs, charitable intentions, tax considerations, and overall financial objectives. For clients who do not need the full distribution for living expenses, several planning opportunities may help reduce the tax impact of an RMD while supporting broader financial goals.
Timing your first RMD
Retirees have an option to postpone their first RMD until April 1st of the year following the year they reach their required beginning age. While this can be beneficial in certain situations, it is important to evaluate the tax implications carefully.
If income is estimated to be higher in the first year than the second, postponing the first RMD may be worth considering. However, delaying the first distribution means taking both the delayed RMD and the following year’s RMD in the same calendar year, which can increase taxable income.
In addition, the RMDs may cause a greater portion of Social Security benefits to be taxable, so it’s important to analyze the effects on the taxability of benefits in deciding whether to postpone the first year’s RMD.
Leveraging charitable giving
Another way Truepoint helps clients plan to reduce tax impact associated with an RMD is through Qualified Charitable Donations (QCDs) directly from the IRA. Under current rules, individuals age 70½ or older can transfer up to $111,000 annually from an IRA directly to qualified charities.
For individuals who are already subject to RMDs, a QCD can satisfy part or all of the annual distribution requirements while excluding the amount transferred from taxable income. In addition, charitable distributions made before reaching RMD age reduce the IRA balance, which may result in lower RMDs in future years.
For many retirees, this approach can provide a greater tax benefit than writing a check to charity, particularly if they do not itemize deductions. By reducing adjusted gross income, a QCD may also help limit the taxation of Social Security benefits and reduce exposure to Medicare premium surcharges.
Consider in-kind distributions
For those clients with additional resources who do not need the immediate cash flow from a required distribution, an in-kind distribution of securities may be worth considering
Rather than selling investments within the IRA and distributing cash, shares of mutual funds or exchange-traded funds can instead be transferred directly to a taxable investment account. The value of the shares transferred satisfies the RMD requirement and creates the necessary taxable event, while keeping the investment allocation largely unchanged. This approach can help avoid unnecessary trading and maintain a portfolio’s intended investment strategy.
Taking advantage of tax withholding
For individuals who make quarterly estimated tax payments, RMDs can also provide an opportunity to simplify tax payments.
Federal and state taxes can be withheld directly from an IRA distribution at any point during a given year. Unlike estimated tax payments, withholding is generally treated as though it occurred evenly throughout the year, even if it is taken from a single distribution. In some situations, this can help satisfy tax obligations while improving cash flow management during the year.
While RMDs are a required part of retirement planning, the way they are managed can have a meaningful impact on taxes, cash flow, and long-term financial goals. Evaluating the available alternatives can help ensure that RMDs are incorporated into an overall financial plan in the most effective way possible.
