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Retirement Conundrum: What to Do with Unneeded RMDs

As you approach age 73 (or 75, depending on your birth year), you’ll need to start taking Required Minimum Distributions (RMDs) from your tax-deferred accounts, such as IRAs and 401(k)s. But what if you don’t need the money to cover living expenses? One option is to reinvest it, and a Roth IRA might seem like a perfect choice. However, there’s a catch: you can’t directly convert your RMDs to a Roth.

A Potential Workaround

While you can’t convert RMDs directly, you can contribute up to $7,000 (plus an additional $1,000 if you’re 50 or older) to a Roth IRA in 2024, provided you have enough earned income. Earned income includes wages, commissions, bonuses, and self-employment income, but excludes pension payments, interest income, dividends, and Social Security benefits.

Income Limits and Restrictions

To contribute to a Roth IRA, your modified adjusted gross income (MAGI) must be below certain thresholds. For single filers, the maximum contribution starts phasing out at $146,000, while for joint filers, it’s $230,000. Additionally, you’ll need to wait five tax years after your first Roth contribution to make withdrawals.

Alternative Strategies

If you don’t qualify for a Roth contribution or prefer not to contribute, you have other options to reduce or delay RMDs:

• Roth Conversion: Convert your IRA to a Roth account after taking your RMD for the year. You’ll pay taxes on the converted amount, but future withdrawals will be tax-free.
• Charitable Contribution: Use a Qualified Charitable Distribution to donate your RMD to a recognized charity, avoiding taxes on the donated amount.
• Keep Working: If you’re still employed, your 401(k) account isn’t subject to RMDs. Consider rolling previous employer plans into your current plan to avoid RMDs.
• Be Cautious: Failing to take an RMD can result in a 50% penalty on the missed amount. Consult a financial advisor to navigate these risks.

Tax-Efficient Retirement Planning

To minimize taxes in retirement, consider the following strategies:

• Withdraw from IRAs Early: Reduce the size of your eventual RMDs by withdrawing from IRAs early in retirement.
• Delay Social Security Benefits: Increase your benefit amount by 8% each year until age 70.
• Coordinate Taxes and Withdrawals: Balance taxes, withdrawals, and RMDs between spouses, and remember that younger spouses’ RMDs aren’t required until age 73 or 75.
• Invest in Tax-Free Bonds: Consider investing in tax-free bonds to reduce taxable income.
• Harvest Tax Losses: Offset capital gains by harvesting losses in taxable investment accounts.

Seek Professional Guidance

Managing RMDs and minimizing taxes in retirement can be complex. Consult a knowledgeable financial advisor to create a personalized plan and ensure you’re making the most of your retirement savings.