The retirement savings you have accumulated in a tax-deferred 401(k) or individual retirement account will be considered taxable income when it is distributed. This means you can expect to owe taxes when you take funds from the account. The timing of your retirement account withdrawals can play a role in how much tax you pay on your retirement savings.
Consider these retirement account withdrawal strategies:
— Take required minimum distributions to avoid penalties.
— Withdraw funds in years when you are in a low tax bracket.
— Convert to a Roth.
— Incorporate charitable giving from your IRA.
Take Required Minimum Distributions
Required minimum distributions refer to the minimum amount you must take from your traditional 401(k) and IRA each year. The starting age is 72 years old, or 73 for those who turn 72 after Dec. 31, 2022. You will need to pay income tax on each withdrawal. The penalty for skipping a required minimum distribution is 50% of the amount that should have been withdrawn from the account.
Generally, you must take your first required minimum distribution by April 1 of the year after you reach the starting age. Your second and all subsequent RMDs will be due by Dec. 31 each year. Some people take their first distribution by Dec. 31 to avoid having to take two distributions in the same year and triggering an abnormally large tax bill.
[See: 12 Ways to Avoid the IRA Early Withdrawal Penalty.]
A RMD is typically calculated by dividing your account balance by an IRS estimate of your life expectancy. A spouse’s age must also be factored into the calculation if your spouse is more than 10 years younger than you and the sole beneficiary of the IRA.
You can take multiple withdrawals from the account throughout the year as long as the minimum withdrawal amount is satisfied by the end of the calendar year. You can also withdraw more than the required minimum amount, but excess withdrawals cannot be used to satisfy the RMD for a future year.
“RMDs make sure you get a minimum distribution each year, which helps to provide a sufficient retirement income,” says Sara Sharp, founder and partner at SK&S Law Group in Denver.
Withdraw What Keeps You in a Low Tax Bracket
Between ages 59 1/2 and 73, you are allowed to withdraw money from retirement accounts without triggering the 10% early withdrawal penalty, but are not yet required to take distributions from the account. Some people elect to start withdrawals during their 60s, especially if they have already retired and are in a low tax bracket.
Since distributions are not required during your 60s, you can withdraw only enough to pay a low tax rate on your distributions. For example, if you want to pay a 12% tax rate on your retirement account withdrawals, you can withdraw only enough to keep your taxable income below $44,725 as an individual or $89,450 as part of a married couple in 2023.
You can opt for systemic withdrawals from the IRA in retirement. “With this approach, you set up a regular schedule to withdraw a fixed amount from your IRA,” says Chuck Zuzak, a financial planner and director of financial planning at JFS Wealth Advisors in Pittsburgh.
“It provides a consistent income akin to a paycheck, but may be unsustainable if your portfolio is too volatile and the withdrawal rates are too high as a percentage of the overall account value,” he says. You’ll want to check how the amounts will impact your total taxable income as well.
[READ: How to Pay Less Tax on Retirement Account Withdrawals.]
Convert to a Roth
You might be able to convert your retirement savings to a Roth IRA. A Roth IRA conversion allows you to pay the income tax on your retirement savings in the year you transfer your money from the traditional 401(k) or IRA to the Roth IRA. You then won’t have to pay income tax on future investment gains or withdrawals from a Roth IRA that is at least five years old.
“Retirement income from qualified Roth IRA distributions is tax-efficient since they are tax-free,” Sharp says. “Because there are no RMDs during the account owner’s lifetime, Roth IRAs also provide additional freedom with withdrawals.”
The funds in the account can continue to grow until you need the money or be passed on to heirs. “If a person also has Roth IRA assets, it may be better to let those grow as much as possible,” says Kevin Chancellor, a financial advisor at Black Lab Financial Services in Melbourne, Florida. You could take withdrawals from other accounts that have tax deferred assets in the meantime. In the Roth IRA, assets “grow tax free, are not subject to RMDs, and are a great way to transfer wealth to beneficiaries,” Chancellor says.
[Read: IRA Rules: Contributions, Deductions, Withdrawals.]
Incorporate Charitable Giving
You can avoid paying income tax on withdrawals from your IRA if you are willing to donate the money to charity. IRA owners age 70 1/2 or older can transfer up to $100,000 per year ($200,000 for couples) directly from an IRA to an eligible charity without owing income tax on the transaction. A qualified charitable distribution will also satisfy the minimum distribution requirement for an IRA.
“If charitably inclined, consider making a qualified charitable distribution in lieu of your RMD for the year to avoid recognizing income,” Zuzak says. When the funds are given to charity, they are not considered to be income and won’t appear on your tax return. This can be one way to support an organization or cause and also manage your taxable income in retirement.
More from U.S. News
Factors to Consider Before Cashing Out a 401(k)
How to Pay Less Tax on Retirement Account Withdrawals
12 Ways to Avoid the IRA Early Withdrawal Penalty
Retirement Account Withdrawal Strategies originally appeared on usnews.com
Update 05/31/23: This story was published at an earlier date and has been updated with new information.
