If you think putting money down for retirement is challenging, wait until you figure out how to withdraw it while paying the least tax possible. State and federal income taxes and any estate or inheritance taxes can eat up as much as 70% of your retirement savings.
Most people would rather keep that sum of money for themselves. But what steps need to be taken to make it happen?
Consider three innovative withdrawal options to avoid falling into tax traps and save more of your retirement savings.
Observe the prescribed procedures for RMDs
When you reach the age of 73, you are obliged to withdraw an RMD from many retirement funds, including a standard IRA or 401(k) plan.
Your first RMD (required minimum distribution) must be taken by April 1st of the year following your turn 73, and all successive RMDs must be taken by December 31st. For example, if your 73rd birthday is in 2023, your first RMD must be taken by April 1st, 2024.
The SECURE Act 2.0, passed in late 2024, raised the RMD starting age from 72 to 73 for the following year, 2023. In 2023, RMDs must be taken by everyone already taking them, but no one is required to begin taking them then. Starting in 2033 on January 1st, the age at which RMDs are paid will climb again, this time to 75.
Serious consequences await anyone who chooses to disobey the law. If RMDs are not made by the required date, an enormous excise charge of 25% will be imposed. If you fail to take an RMD from an IRA but catch your error and re-file your taxes immediately, you may only have to pay a 10% penalty instead of the maximum 25%.
Underpayment has the same effect. Suppose you need to consider your RMD for the year and end up with a $5,000 distribution instead of the required $20,000. The Internal Revenue Service will charge you the 25% penalty, which equals $3,750 (i.e., 25% of $15,000).
Remember that the amount you must withdraw each year to satisfy your RMD will vary yearly. That’s because it’s based on factors like age, life expectancy (a more extended life means a smaller distribution), and account balance (the value of your assets as of December 31st of the year before you take a distribution).
Take money out of your accounts in the correct sequence.
Refrain from giving in to the temptation of short-term gain while deciding whether or not to withdraw funds from a retirement account such as an individual retirement account (IRA), employer-sponsored retirement plan (401(k), or Roth IRA) to make ends meet. The cost of not taking advantage of a Roth IRA distribution could be higher than the tax savings.
Instead, it’s best to take money out of tax-deferred accounts first and wait as long as possible to touch Roth IRAs.
Skeptical? Take the example of a 73-year-old in the 24 percent tax bracket who withdraws $18,000 from a regular IRA: They have a tax bill of $4,320 to pay. Withdrawing the same amount from a Roth IRA would incur no tax liability. On the other hand, if this person didn’t have to draw an RMD from their Roth IRA and let it grow at 7% per year for another ten years, the account balance would be $35,409. Earnings in a Roth IRA are not subject to taxes when withdrawn by the account holder or their beneficiaries.
Learn the ins and outs of receiving payments.
With retirement rapidly approaching, you may face the challenge of deciding how to withdraw funds from multiple retirement accounts held at various institutions.
Can you imagine having to drain every single one of your bank accounts? Most likely not.
Withdrawals can be made from any of your traditional IRAs if you have more than one. It could be more cost-effective to consolidate your financial holdings into a single IRA and remove the funds simultaneously.
Consider merging your many IRAs into a single account for less administrative burden, more accurate projections of future withdrawals, and more discretion over your portfolio’s composition.
To sum up
You can lessen the financial impact of the government’s taxation on retirement plan payouts with little planning and know-how. It’s a tricky position, so looking for a financial advisor who will look out for your best interests and help you get through it is worth it. Learn the steps to take to locate a competent guide.
Investors should do their due diligence on different investment techniques before committing capital. In addition, traders should know that the past success of a particular investment product is no indication of its potential future success.