4 Strategies to Limit Required Minimum Distributions (RMDs)

Is there a way to limit the impact of required minimum distributions (RMDs)? They are a part of life for investors who have reached age 73 and have a traditional 401(k) or individual retirement account (IRA). For years, the age threshold was 70½, but it was raised to 72 following the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The RMD age was increased again at the end of 2022 to 73 as part of SECURE 2.0.

The onset of RMDs can put eligible taxpayers in between the proverbial rock and the hard place. If you don't take them, or withdraw the proper amount, you'll owe substantial penalties. But if you do take them, they'll boost your taxable income—and hence, your income taxes for the year (unless the account in question is a Roth IRA or 401(k) that has been funded with after-tax dollars).

If you are nearing the age to take RMDs and want to avoid the extra income and its tax implications, there is good news: A handful of strategies exist to limit or even eliminate the requirement. Below, we'll take a look at four ways to manage RMDs when you don’t need the money.

Keep Working

One of the main reasons for RMDs is that the Internal Revenue Service (IRS) wants to get paid for previously untaxed income. However, savers in a 401(k) who continue working past 73 and don’t own 5% or more of the company, can delay distributions from the 401(k) at their current workplace until they retire.

If you have an IRA or a 401(k) from a previous employer, you will have to follow the RMD rule. Not taking a distribution means you’ll face the excess accumulation penalty, which used to be 50% of the required distribution. If, for example, your RMD is $2,000 and you don’t take it, you'll be on the hook for $1,000. At the end of 2022, Congress changed the required distribution penalty assessment. Now, individuals are assessed a penalty of 25%. Today, that $2,000 RMD that is not taken would result in a penalty of $500.

Convert to a Roth IRA

Another strategy for wealthy savers looking to avoid drawing down required distributions is to roll over some of their savings into a Roth IRA. Unlike a traditional IRA or Roth 401(k), which require RMDs, a Roth IRA doesn’t require any distributions at all. That means the money can stay—and grow tax-free—in the Roth IRA for as long as you want, or it can be left to heirs.

Contributing to a Roth IRA won’t lower your taxable income, but you don’t have to pay taxes on withdrawals from earnings if you are over 59½ and you have had the account open for five years or more. Investors who have a mix of money in a Roth IRA and traditional retirement savings accounts can manage their taxes more effectively.

Be aware, though, that moving pre-tax money from a retirement account into a Roth IRA means you have to pay taxes all at once on those funds. Roth conversions can be expensive, whether you’re moving money from a 401(k) or a traditional IRA. Investigate your options in detail with your tax advisor.

Limit Distributions in the First Year

A big knock against RMDs is the taxes investors have to pay as a result of drawing down some of their retirement savings. This can potentially push a retiree into a higher tax bracket, which means more money going to Uncle Sam. Retirees who turn 73 have until April 1 of the calendar year after they reach that age to take their first distribution. After that, they must take it by Dec. 31 on an annual basis.

Many retirees opt to hold off on taking their first RMD because they figure they will be in a lower tax bracket when they retire. While holding off makes sense for many, it also means you will have to take two distributions in one year, which results in more income that the IRS will tax. This could also push you back into a higher tax bracket, creating an even larger tax event.

Here’s a better option: Take your first distribution as soon as you turn 73 (unless you expect to end up in a significantly lower tax bracket) to prevent having to draw down twice in the first year.

Donate Distributions to a Qualified Charity

Some savers, particularly wealthy ones, would rather see their money go to a good cause than give some of it to the government. Traditional IRA account holders can donate their RMD to a qualified charity. This is known as the qualified charitable distribution (QCD) rule. It does not apply to a 401(k).

In 2021 and 2022, if the contribution is $100,000 or less—and is rolled out of the IRA and directly to the charity—you won’t have to pay taxes on the RMD. In order to get the tax break, the charity has to be deemed qualified by the IRS. This is a good way to save on paying taxes, as you donate to a charity that would otherwise have gotten a donation from your regular savings. You may even feel you can give a bit more if you do it this way.

The Bottom Line

Many people rely on RMDs to fund their retirement years. However, for those who don’t need the money, limiting the tax exposure from RMDs is the name of the game. Delaying retirement, converting to a Roth IRA, limiting the number of initial distributions, and making a QCD are four strategies that can help reduce the tax exposure that comes with RMDs.