RMD Planning Before Age 70.5

Waiting for the Government to decide when one should pull money from their retirement account is usually not the best approach. At age 70 & ½ most owners of retirement accounts must begin to take distributions from their accounts and pay taxes on the distribution. It is most likely beneficial to do some planning before the required distribution date in order to reduce RMDs later in life and pay taxes at more favorable rates throughout life.

Roth Conversions

Roth conversions are a technique in which one takes pre-tax money (typically an IRA), converts it to a Roth IRA, and pays taxes on the amount converted. For example, assume that John has an IRA worth $200,000. John can take all $200,000, or he can take a portion of that money and convert it to a Roth IRA. If John took $100,000 and converted it to a Roth IRA, it would count as and additional $100,000 of taxable income on his tax return in that year. Often, the analysis done a Roth conversion is deciding if it is better to pay taxes now or in the future. The general rule of thumb is that one would want to pay taxes at the lowest anticipated tax brackets. The great thing about Roth conversions are that one can do it at any age and they are not subject to the 10% early withdrawal penalty. If money is converted to a Roth IRA, then it is no longer subject to RMDs and it allows the individual the flexibility to take money out of the account at their own pace.

Delay Social Security, Pull from an IRA

A creative way to effectively reduce future RMDs is to use pre-tax retirement money before using Social Security Income. At age 59 & ½ (sooner for some accounts) one can take a distribution from their retirement account without being subject to the 10% early penalty. Social Security Income can be claimed as early as 60, but each month one delays up to age 70, the Social Security benefits increase. Social Security is also taxed more favorably than a pre-tax retirement account distribution. Therefore, it may be advisable to begin taking distributions from an IRA before the required beginning date of 70 & ½ and delay taking Social Security Benefits in order to allow them to increase. If one pulls from an IRA early, then it will reduce the balance in the account and therefore reduce the RMDs later in life.

HSA Planning

An HSA is an account used to pay for medical expenses, but it also has other benefits used for RMD planning.  In order to qualify for an HSA, one must participate in a High Deductible Health Plan of $1,350 for an individual or $2,700 for a family and also not have total yearly out-of-pocket expenses of $6,650 for an individual or $13,300 for a family. One can contribute up to $3,500 to an HSA for single coverage or $7,000 for family coverage. There is also a once per lifetime rollover that is allowed up to the contribution limit for that year. For example, one may rollover an IRA in the amount of $7,000 to a family coverage HSA account, but in doing so they may not contribute anymore in that year or do another rollover for the rest of their life. Inherited IRAs are also allowed to be rolled over and count towards the RMD from that inherited IRA for the year. When contributing to an HSA, one gets a tax deduction just like an IRA. You may also invest money within an HSA similar to an IRA, so it acts very much like an IRA.

What is unique about an HSA is that, after age 65, there is no 20% penalty for withdrawing funds and using them for things other than qualified medical expenses. Also, there are no RMDs on an HSA. Money is still taxed as ordinary income when you take a distribution from an HSA, but there is no requirement to pull it out of the account at 70 & ½. HSAs allow you to control the timing of distributions from the account.

Conclusion

RMD planning comes down to paying taxes while in the lowest tax bracket, thinking about one’s overall financial picture (not just one account), and controlling the distributions as much as one can. A pre-tax retirement account is worth much less after taxes, so it makes sense to take control of the taxes rather than let the government decide the tax rate and time of distribution.