One of the most common questions I get from readers is, “When should I start thinking about required minimum distributions?” My response often is, “as soon as you start investing.”

As a primer, annual required minimum distributions (RMDs) are mandated for traditional, tax-deferred accounts such as IRAs and 401(k) employer-sponsored plans starting the year you reach age 70½. Although you may enjoy the benefit of tax-advantaged compounding and tax-deductible contributions, the reality is, these savings will be taxed when you withdraw them. While it may not seem instinctive to worry about RMDs before you’re required to take them, the investing decisions you make today can impact your options for taking tax-efficient distributions in retirement and planning for bequests. Here are some practical guidelines for thinking about RMDs in advance—no matter how old you are.

Age 70½ and beyond: The RMD “reality show”

At this point, your options are limited as you’re subject to distributions. But there are still some things you can do to ease the tax bite caused by additional taxable income.

▪If you’re charitably inclined, your first course of action can be to make full use of a qualified charitable distribution (QCD). With a QCD, you can distribute up to $100,000 from your IRA to a qualified charity once you turn age 70½. The added bonus with this type of distribution is that the QCD isn’t subject to federal income taxes—in other words, the amount is excluded from your adjusted gross income. (Note that this amount can’t also be deducted as a charitable gift.) Keep in mind, the QCD option is available to every account owner. For married couples, this means the spouses can each make an annual QCD after they reach age 70½.

▪Take the RMD while rebalancing. This will help maintain the risk profile of your portfolio.

▪If you’re lucky enough not to need your RMD for spending, consider:

  • Reinvesting the net proceeds in a nonretirement account, being mindful of selecting tax-efficient investments such as broad-market index funds or municipal bond funds.
  • Converting to a Roth IRA after you satisfy your RMD. While RMDs aren’t eligible for rollover or conversion to another IRA, the IRS has no issue with you taking more from the IRA than required.

◊ If you’re in a low marginal income tax bracket, you can take advantage of your low tax rate by withdrawing your RMD and doing a partial conversion. (Keep in mind, both your RMD and the amount you convert will be taxable, which will accelerate your income.) Converting some traditional assets to Roth provides you with tax diversification, which can give you more flexibility when spending in retirement. It also reduces your traditional IRA balance, which will be subject to future RMDs.

◊ If you’re making a QCD, you may choose to do a partial conversion (which increases your income) in addition to taking a QCD (which isn’t reported as income). You’ll satisfy your RMD, your QCD won’t be subject to income tax, and you’ll get the extra benefit of tax diversification.

▪You have a onetime option to defer the RMD for the year you turn 70½ until April 1 of the following year. While this seems compelling, keep in mind, you’ll then need to take 2 RMDs during the following year. Taking 2 RMDs could push you into a higher marginal tax bracket, causing you to pay higher taxes on the extra income.

Ages 60–70: The RMD “acceleration decade”

I refer to this stage as the RMD planning “sweet spot” because with careful planning, there are strategies that can help you set the stage now for lower RMDs in the future.

▪If you’re still working, make sure you maximize your contributions to tax-advantaged accounts. You most likely have larger balances in traditional, tax-deferred accounts, so before you add more to those accounts, consider diverting additional savings to a Roth option to build tax diversification. While you won’t benefit from tax deductions on the contributions, withdrawals from the Roth account will be tax-free. And Roth IRAs aren’t subject to RMDs in retirement.

▪If you’re retired (or winding down to retirement!), these years may provide prime planning opportunities to build tax diversification and lower future RMDs.

  • Consider your options with claiming Social Security benefits. One strategy could be to spend from your tax-deferred assets between retirement and age 70 while deferring Social Security. This will increase your Social Security benefits and reduce future RMDs.
  • Another option is to consider Roth conversions.* Though the amount you convert will be subject to income taxes, you may be in a lower tax bracket, especially if you’re deferring Social Security to age 70. Be very careful with how much you convert as it may not only push you into a higher marginal tax bracket in the year of conversion, but could also impact other things including taxation of Social Security (for those receiving benefits) and Medicare Part B premiums (which are based on income thresholds). Roth distributions, on the other hand, don’t negatively impact the taxation of Social Security or increase Medicare Part B premiums … so you may be incurring some “short-term pain for long-term gain.”

▪ If you have a Roth 401(k), consider rolling it over into a Roth IRA to avoid having to take unnecessary RMDs.

Under age 60: The “tax-diversification trifecta”

For those of you in this broad stage, the focus should be to make full use of tax-advantaged accounts. As accumulators, you can be thoughtful about investing in 3 distinct types of accounts: tax-deferred, Roth, and taxable nonretirement accounts. These accounts have different tax structures, which can help you distribute the burden of taxes throughout your investing life. You can also explore other account types such as heath savings accounts, which offer different financial benefits.

I introduce these strategies as guidelines for you to consider. Let them serve as starting points as you make decisions about investing in and withdrawing from your portfolio. At any age, you have many options to help manage tax efficiency and you may want to consider partnering with a financial planner to personalize your plan.

Special thanks to my colleague, Hank Lobel, for his contributions to this blog.

*Roth withdrawals are assumed to be in the following order: contributions, then conversions, and lastly earnings. Account owners under the age of 59½ who withdraw conversion dollars and don’t meet the IRS-approved exceptions will face a 10% penalty. There are no taxes on earnings as long as you’ve held the account 5 years and you’re age 59½ or older, or a special exception applies. Withdrawals from traditional IRAs are assumed a pro rata share of pre-tax contributions, earnings, and post-tax contributions (your basis). Generally, if you make a withdrawal from a traditional IRA and you’re under the age of 59½, you’ll be subject to income tax and a 10% penalty.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • We recommend that you consult a tax or financial advisor about your individual situation.