How to Avoid the Potential Pitfalls of RMDs

Saving for retirement in a traditional IRA or 401(k) plan comes with significant tax benefits, allowing you to defer taxes on your contributions and potentially grow your nest egg faster. However, there’s a downside to these tax-deferred accounts: required minimum distributions or RMDs. Here’s why RMDs can be problematic and what you can do to avoid them.

RMDs are calculated annually based on your retirement account balance and life expectancy. Essentially, they require you to withdraw a portion of your traditional IRA or 401(k) balance each year once you reach a certain age, typically starting at age 70½.

For some retirees, RMDs aren’t an issue because they need to withdraw funds for living expenses. However, if you’re forced to take out more than you need, RMDs can create unexpected tax liabilities.

Tax Implications on Social Security Benefits. RMDs can push your income higher, potentially subjecting your Social Security benefits to taxation. If your combined income exceeds certain thresholds ($25,000 for singles, $32,000 for married couples), a portion of your benefits may become taxable. Even if you were not taxed on your Social Security benefits before, RMDs could change that.

Increased Medicare Premiums. RMDs can also inflate your income, resulting in higher Medicare premiums. Medicare Part B premiums are subject to an income-related monthly adjustment amount (IRMAA), and RMDs could push you into a higher income bracket, triggering additional charges. This applies not only to Part B but also to Part D drug plans, potentially leading to higher healthcare costs.

To avoid the negative impact of RMDs, consider these potential solutions:

Roth IRAs or Roth 401(k)s. Contributions to Roth accounts are made with after-tax dollars, meaning you won’t face RMDs in retirement. Roth accounts no longer have RMDs, and there are no income limits for contributions, making them an attractive choice for many.

Consult with Professionals. Speak with a financial advisor or tax accountant to develop strategies for managing RMDs. They can help you navigate the complexities of tax planning in retirement and ensure you’re making the most of your savings.

While traditional retirement accounts offer tax benefits, RMDs can sometimes complicate your financial situation in retirement. Contact our office so that we can help you explore alternative savings strategies to better prepare for a secure retirement. Then, as your target retirement date approaches, we can reassess your situation and make any changes that might become necessary to prevent complications.