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Two Strategies for Avoiding Required Minimum Distributions

Two Strategies for Avoiding Required Minimum Distributions

July 05, 2022
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It’s seems inevitable. Once you turn age 72 you have to start taking Required Minimum Distributions from your pre-tax 401(K) accounts or Traditional IRAs, right?

Not necessarily.

If you’re still working at that age and don’t own more than 5% of your current company, you may not have to take RMDs from your 401(k) plan.

It’s only when you retire that you’ll have to start taking these distributions. For example, if you leave your company at age 75, you’ll have to take your first RMD by December 31 of that year.

What about your other retirement accounts?

This RMD exemption only applies to your current 401(k) plan. If you have a 401(k) account with a former employer or a Traditional IRA (including non-Roth rollover IRAs) you’ll have to take annual RMDs from those accounts starting at age 72.

However, with a little footwork you may be able to avoid taking any RMDs as long as you’re still employed.

How? By transferring balances from your eligible inactive 401(k) plan accounts and Traditional IRAs to your current employer’s 401(k) plan, if your plan allows it.

If you’re under age 72 and move assets directly from these accounts these transfers won’t be treated as taxable distributions.

However, if you’re 72 or older, you’ll need to take RMDs from these outbound accounts before you move the remaining balances into your current 401(k) plan.

What happens after you retire?

Once you leave the workforce permanently, you’ll have to start taking RMDs from your “consolidated” 401(k) account starting at age 72.

Normally at this point you might choose to move these assets into a rollover (Traditional) IRA which may offer a wider variety of investment options (and possibly lower fees) than your 401(k) plan. Another advantage is that your financial advisor can invest and manage your IRA assets on your behalf.

However, if the idea of taking RMDs after you retire still bothers you, or you want to pass on your IRA assets to your spouse or children without requiring them to take RMDs from your account, you may want to consider converting some or all of your rollover IRA assets to a Roth IRA.

With a Roth IRA you never have to pay taxes on earnings or distributions or take RMDs once you’ve owned the account for five years. However, Roth IRAs must be funded with after-tax contributions.

Normally, you can’t contribute to a new Roth IRA if your income is above a certain level. And annual contributions are capped at $6,000 per year ($7,000 if you’re over age 50).

However, a strategy known as a “back-door Roth conversion” may let you bypass these restrictions.

Here’s how it works. You decide to convert some or all assets in your rollover IRA to a Roth IRA. The amount you convert can be higher than the regular $7,000 Roth contribution limit.

However, it’s important to keep in mind that the amount you convert is treated as a taxable retirement distribution.

If you’re earning significant income from other sources (such as other investment accounts, rental income or a part-time job) these distributions could move you into a higher tax bracket. This might result in higher taxation of your Social Security benefits and an increase in your Medicare premiums.

Fortunately, you don’t have to convert all of your IRA assets at once. You can spread out the Roth conversions over a period of years to manage the tax consequences.

Before you take action

The rules for executing these RMD-avoiding strategies can be very complex and mistakes can be costly.

You’ll want to talk to your 401(k) plan administrator to make sure that your plan accepts rollovers of 401(k) account and IRA money and allows you to avoid taking RMDs while you’re working there.

You’ll also want to make sure these strategies make sense from both a tax and retirement planning perspective. That’s why you’ll want to speak to your accountant or tax preparer and a financial advisor before you take action.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

 

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This article was authored by Dan Flanagan and Jeffrey Briskin. Dan is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or dflanagan@canbyfinancial.com.  Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.

 

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