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What Are the Best Strategies for Reducing RMDs? · Retirement Answers

• 0:00
  Jacob Duke: Hey, friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke. I am your host as always. Hey, I've got a question for you. How frustrating is it to save and build up your different retirement accounts through out your career so that you have the opportunity to step away from work one day and enjoy this next phase of life called retirement, only to be met with all these different rules that seemingly eat away at your hard earned money and savings.
• 0:25
  Things like taxes and social security nuances and IRMA surcharges and health insurance costs before 65 and you can keep going. It can be really overwhelming to work so hard to accumulate enough to be able to retire, only to have to work even harder to protect what you've actually saved. Now, the goal of this podcast here every single week is to share ideas and tips around all of the different topics that you should know about and plan for in retirement. But today I specifically wanna talk about required minimum distributions and how you can work to reduce them in the future. Now, before I jump into the five ways to reduce your RMDs, and I'm gonna save the best for last, so you guys stick around for that one.
• 1:05
  I want to say first that not everyone's goal should be to reduce their RMDs because in reality, they might not negatively affect you specifically. The right ingredients have to be present in your situation for RMDs to actually become a problem. So in reality, RMDs are only a problem whenever those forced distributions exceed whatever amount you would otherwise need to take from your portfolio once you are that age and beyond. So for example, here, let's just say that you're 75 years old here in the future, and you need $50,000 per year from your IRAs at that point in time, on top of maybe a pension and social security or whatever other forms of income you might have. So you need 50,000 in that scenario, but let's say that your RMD is only $40,000 that you're gonna have to take out of your IRAs.
• 1:52
  Well, the RMDs, they're not an issue because you're going to already be taking more than you otherwise would have to take under those rules. But if we keep that $50,000 per year income need at 75 that you need to take from the IRA and then your RMD on the flip side is like $200,000 that you've got to take. Well, that's a big problem. You'd be forced to pay taxes on $150,000 of unnecessary income, pushing you into higher tax brackets and potentially triggering other penalties like IRMA surcharges or net investment income taxes as well. So how do you know if you're someone who's going to have these big RMD issues later on down the road?
• 2:29
  Well, there's no perfect way to determine that, but I'd like to give you just a starting place if I can. If you have less than $1,000,000 in tax deferred accounts today, RMDs likely are not gonna be overly burdensome in the future. Now, if you've got over, let's say $3,000,000 in tax deferred savings, those distributions in the future, they're probably gonna create some sort of problems for you. And if you find yourself in that middle range of 1 to 3,000,000 of tax deferred savings right now today, you're in what I would call the maybe zone. It could go either way for you and 'll be determined a lot based on your situation specifically and what you do over the next few years before you get to RMDH.
• 3:10
  These years between retirement and whenever your RMDs will kick in, they're often referred to as your gap years or maybe your tax valley. This is the period of time that you've got the best opportunity to do tax planning and reduce your RMDs and total tax bill throughout your lifetime. So with that understood, let's talk about these five things. What can you do during these years to reduce your RMDs? And number one is asset location.
• 3:35
  Now I've done individual and specific episodes on this particular topic in the past. So you can go check those out. I'll try to have them linked down in the description below for you as well to go listen to after this one. But asset location is in essence, the intentional investing of certain asset types in different account types, so that how those investments would be taxed is in alignment with the accounts and how those accounts would be taxed. So for example, we love Roth IRAs, right?
• 4:04
  They're really helpful, they grow tax free. There are some different rules around them, but let's assume that all those rules and qualifications are met for all of your distributions out of your Roth IRAs to be tax free in the future. Well, the benefit of a Roth is the growth mechanism being tax free. So you put a $100 into it today, let's say it grows to $300 over the next twenty years, that $200 of growth that we're talking about in this example, that is then tax free money because it is in a Roth IRA. If we know that that account type specifically can have tax free growth happening, it would make the most sense not to include things like cash or low growth assets, maybe like bonds that aren't appreciating over time in those accounts.
• 4:46
  You'd rather hold something that is in high growth mode. You can think of stocks or equities or anything that has the intent of growing in valuation, right? So Roth IRA specifically, you'd want to have the highest growth assets or investments within them. Now, you think about your brokerage account, a taxable brokerage account operates differently from a tax perspective because you're technically putting after tax money into that account, but then you're also paying taxes along the way on interests or dividends or any capital gains that are realized. And then you get to take the money out in the future without any tax burden.
• 5:19
  So you're paying your taxes along the way, depending on what's happening, qualified dividends, non qualified dividends, capital gains or interest, you're paying taxes on that every year. So if you have that account type and you know you're going to pay taxes on the underlying holdings every single year as they earn interest or capital gains are realized, it would make sense to hold the investments that create the least amount of tax drag in that specific account type. So again, if you've got high interest bonds or you've got cash sitting in these accounts, they're gonna create interest, which is gonna be taxable as normal income. So if you want to reduce how much tax you pay on the brokerage account, you might want to think about the higher growth side that pay lower dividends or qualified dividends, and actually you get to realize the gains when you choose to rather than a forced taxation because you're earning interest. So the brokerage account, you have flexibility there, and typically you want to hold something in that account that is going to grow more than it actually creates income.
• 6:16
  Now your IRA, your tax deferred accounts, your four zero one ks's, four zero three b's, anything that is tax deferred, those are tax sheltered, so you put your money in pre tax, you don't pay taxes then, but in the future, you will pay taxes. And this is your account that's going to have these required minimum distributions. So you don't pay tax on the front end, that's why the government says on the back end that either 73 or 75, you've got to start taking those dollars out based on a particular calculation and your age. So that's where the investment type in this account comes into play and how you can actually lower your RMDs in this account type. So if you get into retirement and let's say you need a 70% stock, 30% bond allocation as a whole, let's say you got a million dollars, 70% stock, 30% bond is what your plan would dictate needing as an allocation.
• 7:04
  Well, as much as possible, it would be thoughtful to have that 30% of cash and bonds, whatever the breakdown is there, you'd want as much of that as you can in the traditional IRA, because you're not paying taxes on the interest every single year that you're earning in that bond or cash allocation if it's held in the traditional IRA. But then again, you're also lowering your expected return of that IRA because you have less of a growth focus, which means you're gonna have ultimately less money in that IRA once you do get to RMDH. So in some sense, what you're doing is your household allocation is seventythirty, and what you're not doing with that seventythirty allocation is you're not putting 70% stock, 30% bonds in every single account. You're not putting it that way in your IRA, you're not putting it that way in your brokerage account, you're not doing it that way in your Roth, you've got a household allocation of seventythirty, but each account could be invested differently to make the most of this asset location idea. So, depending on how much money you have in each of those account types, you could have something to the effect of a 50% stock, 50% bond allocation in your IRA, 100% stock in your Roth, and then somewhere close to 100 stock in your brokerage account to make the most of asset locations.
• 8:18
  So by doing this, you're saving on taxes every single year, and then also you're lowering that future RMD because in effect you're lowering the expected future returns on your IRA because you have a higher bond or cash allocation in that specific account. So that's how asset location can help you lower your RMDs in the future, but also lower your tax bill each and every year. Now, the second idea and the second way that you can reduce your RMDs later on down the road is perhaps the most popular and it's Roth conversions. Now, Roth conversions are a talking point, they are a buzzword, they're a big thing when it comes to retirement planning. What I want to do is educate you on Roth conversions and when they're useful and when they're not useful.
• 9:01
  Okay, because the real question you have to ask with Roth conversions is what is the point of the conversion itself? Is it to reduce my RMDs? That'd be a great reason to do Roth conversions. Is it to create tax free income for myself in the future? That might be a reason to do a Roth conversion.
• 9:18
  Is it to leave a tax free inheritance for my kids and grandkids one day? That's a great reason to do a Roth conversion. You could add to this list, but those are the three often and primary reasons to do conversions. But what I want you to know is that Roth conversions are not blanket advice for anyone in retirement to do. Yes, they can be helpful, but they're not always the solution to the problem you're trying to solve, because first you have to understand what the problem is.
• 9:43
  Now, if we're thinking about Roth conversions when it comes to lowering your RMDs, it will absolutely reduce how much money you have in your IRAs, which in turn reduces your distributions in the future that you have to take, right? Makes perfect sense. Now, the question you've got to understand is, what is the cost today to actually do the conversion, which then saves me money in the future? Because if you're trying to do a Roth conversion today, let's say while you're working even, your income is still elevated, you've heard Roth conversions are awesome and help save you a bunch on taxes, but you would be paying a 24% tax rate at the federal level plus any state related taxes that you might have to do that conversion today. But in the future, once you get the RMD age, yes, you might have a large RMD, call it $80,000 but if your only other source of income is social security and that social security income plus this $80,000 you need is enough to cover your expenses every year, Your tax rate in the future, assuming they don't increase taxes dramatically, they're not going to be as high as 24%.
• 10:41
  You're going to be in that ten, twelve, 22% range depending on different factors. Therefore, it would be not smart to convert money today at 24% because you could pay a lower tax rate on that same money in the future once you do get to RMDH. So Roth conversions are not one size fits all, but when do they help? That is the big question. Well, if you've got this $2,000,000 IRA today and you look at yourself and you say, hey, I've got another 500,000 in cash and brokerage, I've got some Roth money set aside as well, I only need $50,000 out of my portfolio on top of my pension and on top of my social security, what am I I can't spend this traditional IRA money fast enough and I really don't have a need for it.
• 11:21
  So what can I do? Well, I could do Roth conversions and so you can build out your projection using some technology and software, that's what we use here with our clients, we like to run the projection and see what are the benefits of the conversion over a lifetime, And if it makes sense, then we'll build that plan out and say, hey, let's convert up to the 12% or the 22% tax bracket so that we can pay that tax rate today and not get pushed in those higher tax brackets in the future once the RMDs kick in. And by doing so, the whole point of the Roth conversion is to actually lower your lifetime tax bill, not your tax bill any given year, this year or even some future year, it's how do we evaluate the entire expected taxes to be paid on this sum of money? How do we lower that over your lifetime? That is the goal.
• 12:05
  Now, there's other factors that get added in here. Let's say that you're married, right? And you've got that $2,000,000 in an IRA and once you do get to 75, it could be expected that's $3,000,000 because you're not spending enough out of the account and it's going to grow some over that amount of time, but then you pass away and your spouse, they're left with this 2 or $3,000,000 traditional IRA in the future. They're the same age as you, let's presume, you're no longer here, they've got to then start filing as a single tax filer, but here's the catch, the RMDs are based on the total account balance. So if the RMD would be the same in terms of dollars, once your surviving spouse gets to that point, now they're filing as a single tax filer, they're paying a much higher effective tax rate due to what's called the widow's tax trap.
• 12:53
  They've survived you, they have the same amount of money, whatever you had is now theirs, They have to pay a higher tax rate effectively on the same amount of dollars that had to be taken out of the account. So the government ends up with even higher tax revenues from that RMD than expected. So you've got a lot to consider here and Roth conversions can be a very powerful tool when it comes to reducing your tax bill, but you've got to consider what does it cost on the front end? How much does that benefit you down the road? And is it truly worth doing?
• 13:22
  And for many cases, tons of people can benefit from them. In other situations, you might not be able to benefit from them. I'm going to hit on this a touch more here in number five. Now, three is an interesting one because I think of this maybe differently than a lot of people. Okay, when it comes to social security, a lot of people think about the break even age, hey, I've got to live to 82 in order to delay it from, let's say 62 to 67 before I take it, if I don't live to 82, I'm giving up money.
• 13:52
  There's a lot that goes into, you know, what's the breakeven age of a social security claiming and when, what's the most optimal time to do it? I would say that if you truly wanna get the most optimal time, it is a very difficult thing to calculate when is the best time to do it, okay? When you start to add in all of the real factors to the equation, not just gross benefit versus gross benefit and how long you have to live to get the difference between the two, it just doesn't work that cleanly because that's just gross benefits, it's not even talking about tax taxable benefits because you could have anywhere from 85% of your benefits taxed or 0% of your social security tax and depending on how you draft up and draw up your income plan and retirement and when you claim what, that is going to impact how much tax you pay on your benefits. So really, you need to be evaluating the break even age on social security with a net after tax total, right? And that again, gets very layered and nuanced.
• 14:48
  And so today, what I'm going say is if you think about number two being Roth conversions, and then number five here a second, delaying social security could help you lower your RMDs down the road. Why is that? Well, the first reason is if you take your social security at 62, let's say, you get it early, you start getting your income. Well, if you've got $2,000,000 saved up and a lot of that's in tax deferred accounts and you've got, I don't know, 40,000 a year coming in from social security because you started it early, that's $40,000 a year you don't need to take out of your tax deferred or traditional IRAs, like, because you've got social security coming in, you don't have to take that money from your savings, which means your savings is gonna continue growing and compounding because you're not taking as much money from it, right? So, you're building up the account larger, which means you're gonna have those bigger RMDs down the road because your fixed income from social security is taking up a large percentage of your monthly income needs.
• 15:45
  So by delaying social security, you can obviously increase your benefit by doing so, but you're gonna increase how much you take from your actual savings, which will reduce how much you have in the accounts, which in turn reduces how much your RMDs will be in the future. So whenever you delay your social security benefits, that's one way is you get to take more from the accounts now, you're like, Jacob, that might be counterintuitive, what if I don't wanna spend down my accounts as much? Well, if we're talking about reducing your RMDs, spending money out of your accounts, I'll talk about this more in number five, but spending money out of those accounts is a great way to reduce the RMD because it means you naturally gonna have less money in the accounts. Simultaneously though, you're also building up this larger social security benefit once you do decide to turn it on. Now, the second benefit of delaying Social Security goes back to number two, and it comes from Roth conversions.
• 16:32
  If you're able to delay those benefits as long as you can fill up the years in which you're not taking your benefits with the Roth conversions, you're going to move more money into Roth, you're paying a lower tax rate on the conversion itself because you don't have social security taking up portions of those lower brackets, the 101222% levels, you can convert more at those lower brackets because you don't have social security getting in the way, and whenever you do it this way, if you were taking social security trying to do a Roth conversion, the Roth conversion, it's very circular. The Roth conversion actually forces more of your social security to become taxable up to that 85% of your benefits cap. So the conversion gets taxed at a higher rate, let's say 22 or 24%, because social security would be taking it up if you took it early, and then because you're doing Roth conversion, because you need to, while taking social security, more of your social security becomes taxable, which means net you get less out of the benefits themselves anyway. So it's the circular thing where because you do want it impacts the other and vice versa.
• 17:32
  That's why sometimes, again, going back to social security and the break even ages on when you should or shouldn't take them, it's very hard to derive the answer to that. Like it truly is if you start to really think about it, because again, if you decide to take it earlier, yes, you you don't have to worry about a break even age, but you're actually hurting dramatically if you do need to do or decide to do these other tax saving opportunities such as the Roth conversion, because now your net after tax benefit of the Social Security is so much lower. You took a 30% reduction on the front end. Now you're taking a tax hit as well, reducing that down to, I don't know, 60% of the the full retirement age benefit that you're actually getting every month to your bank account. That's a long time before you truly get back to a break even on that.
• 18:16
  So Social Security is an interesting topic, but if you want to reduce your RMDs, delaying social security helps you use these other things that I'm talking about, these other methods or strategies to reduce your RMDs even better. It amplifies them because you don't have this fixed source of income getting in the way of making the most of a Roth conversion or asset location or where you pull money from in retirement out of your accounts. Now, before we get to number five, which I think is perhaps one of the maybe most powerful ways to reduce your RMDs in the future, want to talk really quickly about when you get to RMD age in the future, you can use something called a qualified charitable distribution or QCD for short. And if you are charitable or someone who's giving annually and you want to continue that, and you do have these RMDs coming up here in the near future, a qualified charitable distribution is a great way to meet your charitable and giving goals, what you're trying to accomplish there, but also do it in a way that is most tax efficient, because the qualified charitable distribution QCD, you can use that in lieu of the RMD, it will fulfill the obligation.
• 19:24
  So here's an example, let's say that you've got an RMD of $20,000 okay? And you've got to take that out, it's first year of it, you're 73 years old and you've got to take the money out this year. Well, if you give $10,000 every single year to your church or charity of your choice, great, you can continue doing that. But if you do it through the QCD mechanism, you can take 10,000 and give it to the charity, and that offsets $10,000 worth of your RMD, which means that you only have 10,000 left that you've got to take out of the IRA to fulfill your RMD obligations. So you get to gift the money directly from your IRA to the charity that fulfills a portion or all depending on what your RMD amount is.
• 20:07
  But in this example, a portion of the $20,000 required distribution that has to take place, meaning less tax bill for you. You get to fulfill your giving goals, pay less taxes on your tax return because only half of the RMD is actually going to be subject to taxation as a distribution, and therefore you get to lower your RMD. Now, some of you might be thinking, Jacob, what if I just take my $20,000 out and then I give it like normal out of my bank account? Well, the problem there is that the QCD is technically above the line, meaning you don't have to itemize to do a QCD. You still get to use your standard deduction and do the QCD at the same time.
• 20:42
  Now, if you take the distribution out, the 20,000 in this example, put it in your bank account and then you give, well, if you want to maximize that full $10,000 of giving of cash from your bank account to the charity, you've got to itemize to realize that benefit, right? And a lot of people simply can't itemize it. Today's standard deduction amounts being so high. So the QCD is the best way to give once you are at RMD age and QCDs technically, you could start doing those at 7.5. You don't have to wait until RMD age to be eligible for them, but QCDs are a great way to reduce those RMDs once you are at that age and you're someone who is charitable or hopes to be in the future.
• 21:22
  Now, number five, this is the one that I love the most. I'm the biggest fan of this one because I think it gets back to the heart of the matter when it comes to retirement in general, right? Like all these things that we're talking about so far, they're like tax strategy and ideas and hey, if you do this, you could help save taxes here. And what I found in doing this with hundreds of clients all over the country and the conversations we have there, the question always starts is like, hey Jacob, I want to reduce my taxes. And I'm like, great, let's try to do that.
• 21:53
  Let's talk about it and see what we can come up with. But what I found is that's where the goal ends for most people, right? You listen to folks like me and we talk about these ideas and strategies and it's all great and that's what you want and perfect. The problem is, is if we stop there, I think we miss the mark. And so what I don't want to happen is I don't want the tack's tail to wag the life dog, if you will, like I don't want the tail to wag the dog because a lot of people are thinking about taxes and lowering them, but giving up life and enjoyment and satisfaction and fulfillment along the way because of this tax savings goal thing that they've come up with.
• 22:30
  And so number five is, why don't you just spend and enjoy more of your money before you get to RMDH? Right? Like why don't you just enjoy more of it? Because if you got 2 or 3 or $4,000,000 saved up for retirement or even more, and and it's all tax deferred, like go enjoy it. Because you know, you're gonna have these big tax bills down the road if you don't do anything.
• 22:53
  And what you can say is, hey, instead of a Roth conversion of 50,000 this year, I'm going to take the family and grandkids and all on a two week long vacation to pick your favorite spot. And that's going to be the memories of a lifetime that I've made. Yes, I could convert it to my Roth and not go on the vacation. And I had the money still, absolutely not going to deny that. But what's more important to you?
• 23:19
  Having more money or having more memories? With the ones you love. That's what I'm trying to get at here in number five, not just spend more? Because you're gonna if the goal primarily is to reduce your RMD and you know you're already gonna have too much of them anyway, just go enjoy the money and spend more of your money now. Because that will automatically reduce how much money you have and obviously reduce how much your RMDs will be in the future.
• 23:45
  So I think that there what I'm kind of drawing out here is, there are multiple ways to get to the, hey, how do I get lower RMDs in the future? You can do it in many different ways, and here's the reality, a lot of these can work together. You can spend more and do Roth conversions, you can spend more, delay social security asset location correctly and do Roth conversions, and then when you get there, still do a QCD, like none of these are exclusive of each other. In my opinion, they work best when they work together with each other. But I think number five is just most important and I don't know impactful for me because if you only focused on tax savings, yes, you could save taxes in so many of these other ways I'm talking about, but I just truly believe that the tax strategy, the social security income plan, the retirement distribution strategy, you know, all the investment stuff you do and we help with our clients, all those things, they're just the means to the end.
• 24:42
  They're just the means to the life you really want. They're just the means to the fulfillment you're desiring. They're just the means to whatever fill in the blank is for you. And the thing that I see the most is Jacob, I want help with all these things. I'm like, okay, well, why do you want to do those things?
• 24:58
  Well, it's like, well, so I can have more money in my accounts and I can save on taxes and all this stuff is like, but what are you gonna do with And it's like, I don't know. So first you got to identify what is the purpose of lowering your RMDs, like why are you doing that? And if you can get there, enjoy a better life with people you love, doing the things you love the most, then do that first, spend more, enjoy your money, live a great life. And if asset location and Roth conversions and delaying social security and QCDs fit in on top of that, then do them. But you can reduce your RMDs by just spending more of your money.
• 25:38
  Okay? I wanna make that very clear. So hopefully, when it comes to reducing your RMDs, I know it's a big conversation topic, I know it's something that's important, right? Like you don't wanna be forced to take money out that you otherwise don't want to pay taxes on, so how can we get ahead of that? That's the whole idea, I love that you're thinking ahead, but I want you to just stop and pause for a second and say, okay, is there a better, more impactful way to get there in terms of like my life and fulfillment and enjoyment compared to just strategy?
• 26:09
  Because the best strategy could be to spend more. You get a big return on life and memories, and you still reduce your RMDs and if you can fit these other things on top of it, wonderful. So I don't know, just food for thought for you, but these are the five things that I know right away that can help you reduce your RMDs. I'm sure there are others, if you think of others, please shoot me an email and say, Jacob, this is one you may be left off and here's something I'm doing. I'd love to hear about that.
• 26:31
  But also, if it was helpful for you today, I'd love for you to share it with a friend or family member who you think could benefit from it too. Other than that, I hope you have a great day and thank you for tuning in. As always, we'll talk to you again very soon. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice. Retirement Answers is for educational purposes only.
• 26:55
  Thanks for tuning into this week's episode. I look forward to talking with you again next week.