How to Reduce Taxes on Your Required Minimum Distributions

A lot of people think it’s a good idea to save for retirement in a traditional IRA or 401(k) until they realize the flaw in that plan. At some point, these accounts will start imposing required minimum distributions, or RMDs. And if you don’t take them, the penalties could be costly.

Every time you don’t take an RMD on time, you’re assessed a 25% penalty on whatever amount doesn’t come out of your retirement account. So it’s in your best interest to take those mandatory withdrawals when you’re supposed to.

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The problem, of course, is that RMDs could drive up your taxes in a serious way. If you want to reduce RMD taxes, here are a couple of key moves to make.

Do Roth conversions ahead of retirement

RMDs do not apply to Roth retirement accounts. If you convert traditional retirement savings to Roth savings, you can reduce your RMDs, and your related tax bill should follow suit.

That said, when you convert funds to a Roth account, you’re taxed on the sum you move over. For this reason, doing a large conversion in a single year may not be your best move. Instead, you may want to aim to do your Roth conversions over time.

If your plan is to slow down work-wise in your early 60s, leading to a reduced income, that could be a good time to start doing Roth conversions. Similarly, if you plan to retire before RMDs become mandatory, you may have several years when your income is much lower – and when Roth conversions make sense.

Use qualified charitable distributions

If you have a large retirement plan balance, you may be inclined to donate some of those funds to charity. And if you do so the right way, you could enjoy serious tax savings.

There’s always the option to withdraw from your savings and write a check to charity afterward. But if you send money directly from your retirement account to a qualifying charity, you can potentially avoid taxes on your RMDs entirely.

It’s a strategy known as qualified charitable distributions, or QCDs, and you should know that you can only make them from an IRA. If you have a 401(k) plan that’s subject to RMDs, you’ll need to roll those funds into an IRA first if you want to use QCDs to lower your tax bill.

RMDs can be a hassle due to the taxes they create. Planning ahead with Roth conversions and employing QCDs could help reduce those taxes so the IRS doesn’t get to take more of your money.