As you approach or enter retirement, Required Minimum Distributions (RMDs) become an important financial milestone. Understanding what factors influence your RMDs can make a significant difference in how much you pay in taxes, how you manage your retirement income, and how you preserve wealth for your heirs.

In this insight we will take a look at the key factors that impact your RMDs, so you can take control of your retirement strategy and avoid unnecessary tax surprises.

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What Are RMDs and Why Do They Matter?

I recently wrote on this topic, and you can find the insight here: https://www.asmallinvestment.com/8-essential-questions-for-your-rmd-answered/

RMDs are designed to ensure that the government collects taxes on tax deferred savings. While this is expected, the challenge comes when large withdrawals push you into higher tax brackets or disrupt your retirement plans. 

For high-net-worth individuals, these distributions can cause significant tax burdens if not managed carefully.

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Age and When You Start RMDs

Your age plays a big role in when you start taking RMDs. As mentioned, the SECURE Act 2.0 changed the start age to 73 for those born after 1950. 

You can delay your first RMD until April 1st of the year after you turn 73, but if you choose this option, you’ll need to take two RMDs in that year, potentially increasing your taxable income. Most commonly RMD takers will delay their first RMD to take advantage of market gains. 

While this may work in your favor, you may need to plan around the increase to avoid being bumped into a higher tax bracket. If you’re considering this strategy, it’s essential to look at your overall income for that year and see how the extra RMD might affect your tax situation.

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Your Account Balances Determine Your RMD Amounts

The size of your RMD depends directly on your account balances at the end of the previous year. The IRS calculates your RMD by dividing your retirement account’s value by a life expectancy factor from their Uniform Life Table. 

The larger your account, the larger your RMD, and the more taxes you’ll owe. If your account has grown significantly, you might want to consider strategies to reduce your future RMDs. 

One popular approach is converting some of your traditional IRA funds to a Roth IRA. Roth IRAs don’t have RMDs, and while you’ll pay taxes on the conversion now, you’ll reduce your future tax burdens.

For high-net-worth individuals with significant IRA balances, even a small Roth conversion each year can help lower future RMDs and keep you in a lower tax bracket.

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Market Performance Affects RMDs

Market conditions can have a big impact on your RMDs. If your account value surges due to a strong market, your RMD will be larger. Conversely, in a down market, you might end up withdrawing more than you’d like from a lower account balance, potentially locking in losses.

Timing is everything when it comes to managing RMDs during volatile markets. Although I never recommend or suggest timing the stock market, having a plan in place for market rallies and down turns goes a long way.

By reviewing your overall financial plan, we can identify other sources of income, allowing you to take your RMD without tapping into your long-term investments. If you’re facing similar circumstances, it’s worth looking at whether you can fulfill your RMD with cash or more liquid investments to avoid selling in a down market.

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Tax Implications of RMDs

One of the most significant factors that impact RMDs is the tax burden they create. RMDs are taxed as ordinary income, which means they can push you into a higher tax bracket, affect your Medicare premiums, and increase the taxability of your Social Security benefits.

One overlooked strategy is adjusting your tax withholdings to account for your RMD. Many retirees underestimate the impact of their RMDs on their total tax bill and end up paying penalties for underpayment. 

You can opt to have taxes withheld from your RMD to cover your liability for the year. Alternatively, you can adjust your quarterly tax payments to ensure you don’t end up with an unexpectedly large tax bill.

Another approach is to consider Qualified Charitable Distributions (QCDs), which allow you to donate up to $105,000 per year directly from your IRA to a qualified charity. The amount donated via QCDs counts toward your RMD but isn’t included in your taxable income. 

I’ve seen clients reduce their tax burden significantly while supporting causes they care about, it’s a win-win!

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Multiple Accounts and Aggregation Rules

Many people have multiple retirement accounts, including IRAs, 401(k)s, and other employer sponsored plans. RMDs must be taken from each account, but there are specific rules about how you can aggregate RMDs.

For IRAs, you can add up the total RMD amount across all your IRA accounts and withdraw that total from one or more IRAs. However, you cannot combine RMDs from 401(k)s or other employer plans in the same way. Each employer-sponsored plan must have its own RMD withdrawn.

Meeting with an expert in financial planning can help to discuss the options available to you in order to minimize unnecessary withdrawals or to make sure to withdraw enough to cover at least the minimum. 

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Legacy Planning and the SECURE Act’s Impact on Heirs

If part of your retirement plan involves leaving assets to your heirs, RMDs and their rules for beneficiaries play an important role in your legacy planning. The SECURE Act introduced a 10-year rule, requiring most non-spouse beneficiaries to withdraw the entire balance of an inherited IRA within 10 years of the original owner’s death. 

This can create a significant tax burden for your heirs if not planned carefully. For high-net-worth individuals, this rule can lead to substantial tax consequences for the next generation. 

One way to mitigate this is by converting more of your retirement accounts to Roth IRAs during your lifetime. Since Roth IRAs don’t have RMDs and withdrawals are tax-free, this strategy could save your heirs a considerable tax bill down the road.

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Future Legislative Changes

The landscape for retirement accounts and RMDs has changed over the years, and it’s likely to continue evolving. The SECURE Act already moved the RMD age from 70.5 to 73, and there are proposals to increase it further. 

Any future legislative changes could impact your retirement strategy, especially if they affect tax rates or withdrawal rules. Staying informed about these changes is critical. 

I recommend reviewing your RMD strategy at least annually and adjusting it as necessary based on new laws and market conditions. Having a financial planner who keeps an eye on potential changes is invaluable for staying ahead of the curve.

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What’s Next: A Proactive Approach Is Key

Managing your RMDs effectively requires careful planning, especially for high-net-worth individuals. Factors like age, account balances, market performance, tax implications, and legacy goals all play a role in shaping your strategy. 

By understanding these factors and working with a financial professional, you can minimize your tax burden, maximize your income, and ensure your wealth supports your long-term goals.

Whether it’s optimizing withdrawals, adjusting your investment strategy, or exploring tax-efficient options like QCDs, taking a proactive approach will help you navigate the complexities of RMDs with confidence. 

Don’t wait until the last minute, start planning now to make the most of your retirement. Have you made your plan yet?