The 1 Thing You Can't Do With Your Required Minimum Distributions in Retirement
Many retirees favor tax-deferred accounts like traditional IRAs for their long-term growth potential. However, once Required Minimum Distributions (RMDs) begin, the IRS wants its share. Some retirees look to Roth IRAs as a way to grow their savings tax-free, but there's one big restriction.
Here's the one thing you can't do with your RMDs in retirement and smarter strategies to achieve long-term benefits.
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When it comes to RMDs, there's one hard rule that often surprises retirees: they can't be converted to a Roth IRA. It's a common misunderstanding and one that can complicate tax planning if not addressed early.
'Required Minimum Distributions or RMDs, cannot be converted into Roth IRAs because, by the time they happen, it's simply too late,' said Samuel Flaten, certified financial planner (CFP) and partner at Narrow Road Financial Planning. 'The IRS mandates that once you reach a certain age — currently 73, depending on an individual's date of birth — you must begin taking distributions from your pre-tax retirement accounts like IRAs or 401(k) [plans].'
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Allowing conversions of RMDs would let taxpayers bypass the very tax the IRS requires them to pay in retirement. If an individual has taken an RMD for the year, that portion cannot be contributed or converted and attempting to do so could trigger penalties.
'People hear about Roth conversions being smart tax moves and assume they can apply them to anything, including RMDs,' Flaten said. 'But the rule is clear: RMDs must be withdrawn and taxed and only funds above and beyond the RMD amount can be converted to a Roth.'
Many retirees don't realize they've waited too long to start thinking about tax strategy until their first RMD arrives. What seems like a routine withdrawal can trigger a cascade of financial consequences that catch even diligent savers off guard.
'By then you've lost most of your flexibility,' Flaten said. 'In some cases, RMDs can be much larger than expected, especially if you've saved diligently or had strong market returns. When those large distributions hit your tax return, they can cause all kinds of unintended consequences – higher Medicare premiums, more of your Social Security being taxed or just jumping into a higher bracket altogether.'
An overlooked factor is the years leading up to the RMD age, which is a critical window for proactive tax planning.
'If your goal is to reduce future RMDs or minimize the taxes they bring, the best thing you can do is start planning well before they begin. The most powerful strategy is Roth conversions during the early retirement years — after you've stopped working but before RMDs and Social Security begin,' Flaten said.
'During this window, your income may be unusually low, which gives you the chance to fill up lower tax brackets with intentional conversions,' Flaten explained. 'You're effectively pre-paying tax at a rate you can control, which can dramatically reduce RMDs later and create a pool of tax-free income in the future.'
In addition, Flaten said some employer plans even allow in-plan Roth conversions or backdoor Roth contributions while individuals are still in the workforce.
Even retirees who are already subject to RMDs still have meaningful tax-planning opportunities. For those who give to charity, the Qualified Charitable Distribution (QCD) offers a way to fulfill their RMD while keeping that amount out of their taxable income.
A QCD allows retirees to send up to $108,000 annually directly from their IRA to a qualified charity. The amount counts toward their RMD but is excluded from their taxable income.
'For clients who are already charitably inclined, this can be a game changer,' Flaten said. 'I've had more than one client give generously out of their bank account without receiving any tax benefit, simply because they didn't itemize. The QCD bypasses that issue altogether.'
The smartest move of all is early planning.
'The earlier you start planning, the more choices you'll have,' Flaten said. 'RMDs aren't inherently bad, but without a strategy, they can feel punitive. Thoughtful planning, especially in the years leading up to them, can soften the blow and even turn them into part of a broader retirement income plan. The mistake is waiting too long to act.'
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Sources
Samuel Flaten, Narrow Road Financial Planning.
This article originally appeared on GOBankingRates.com: The 1 Thing You Can't Do With Your Required Minimum Distributions in Retirement
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