RMD Strategies to Reduce Taxes on Required Minimum Distributions

Retirement accounts like traditional IRAs and 401(k)s require minimum distributions (RMDs) once you reach a certain age. These withdrawals increase taxable income, potentially pushing retirees into a higher tax bracket or raising Medicare costs. Proper planning can help minimize tax impact while ensuring compliance with IRS rules.

Calculation Factors

RMD amounts are based on your account balance and life expectancy. The IRS uses its Uniform Lifetime Table to determine RMDs for most account holders, with different tables applying in specific cases, such as for those with much younger spouses. The formula divides the prior year-end balance by a life expectancy factor assigned to your age. For example, if you are 75 in 2025 with a traditional IRA worth $500,000 at the end of 2024, the IRS divisor for your age is 24.6, resulting in an RMD of approximately $20,325.

The SECURE 2.0 Act, effective in 2023, raised the starting RMD age to 73 and will increase it to 75 in 2033, allowing retirees to defer withdrawals longer. The IRS periodically updates life expectancy tables, which can slightly alter RMD calculations.

Market fluctuations affect RMD amounts. A market decline late in the year can cause a higher withdrawal percentage relative to the current balance since RMDs are based on the prior year-end value. Conversely, strong market performance leads to larger distributions, increasing taxable income. Monitoring portfolio performance and rebalancing can help manage tax exposure.

Timing Options

Retirees must take RMDs by December 31 each year but can decide when within the year to withdraw. Timing affects tax liability, investment growth, and cash flow.

Taking RMDs early ensures compliance and provides immediate access to funds for living expenses. However, withdrawing early may forgo potential market gains.

Spreading RMDs over multiple withdrawals throughout the year helps manage income fluctuations and provides steady cash flow. Some retirees opt for monthly or quarterly distributions to mimic a paycheck, making budgeting more predictable. This strategy also reduces the risk of withdrawing a large sum during a market downturn.

Waiting until later in the year allows more time for tax-deferred growth. In strong market years, this can increase account value before withdrawal. However, delaying may result in a larger taxable event if account values rise significantly.

Account Aggregation Issues

Managing RMDs is more complex with multiple retirement accounts. The IRS allows flexibility in how distributions are taken across accounts, but different rules apply based on account type.

Traditional IRAs, including rollover and SEP IRAs, can be aggregated for RMD purposes. While each IRA has its own RMD calculation, the total required amount can be withdrawn from one or multiple IRAs. This allows for strategic withdrawals, such as taking from lower-performing assets while letting stronger investments continue growing. However, 401(k)s and other employer-sponsored plans require separate RMDs from each account. Failing to withdraw from each 401(k) results in a penalty of 25% of the missed amount, reduced to 10% if corrected within two years under SECURE 2.0.

A common mistake is assuming an IRA RMD satisfies a 401(k) requirement, which it does not. Those with multiple 401(k)s must take RMDs from each plan separately unless they consolidate accounts. While consolidation simplifies compliance, it requires careful planning to avoid unintended tax consequences or loss of investment options.

Taxable and Nontaxable Splits

The tax treatment of RMDs depends on the type of contributions and earnings within the account. Traditional IRAs and most employer-sponsored plans consist of pre-tax contributions and tax-deferred growth, making the full RMD amount taxable as ordinary income. However, accounts with after-tax contributions, such as non-deductible IRAs or certain 401(k) plans, have a portion of distributions that may be tax-free.

The IRS requires distributions from accounts with both pre-tax and after-tax funds to be taken on a pro-rata basis. This means withdrawals must include a proportionate share of taxable and nontaxable amounts. The pro-rata rule is calculated using IRS Form 8606, which tracks after-tax contributions in IRAs. For example, if an IRA has a $200,000 balance with $40,000 in after-tax contributions, 20% of any distribution would be tax-free, while 80% would be taxable.

Roth Conversion Considerations

Roth conversions can help manage RMDs and reduce taxable income in retirement. Since Roth IRAs do not have RMDs during the account holder’s lifetime, converting funds from a traditional IRA or 401(k) to a Roth IRA reduces future mandatory withdrawals. However, converted amounts are taxed as ordinary income in the year of conversion.

Converting in years with lower taxable income—such as early retirement before Social Security begins—can minimize taxes. Spreading conversions over multiple years helps avoid pushing income into higher tax brackets. For example, if a retiree has room within the 22% tax bracket before reaching the 24% bracket, converting only up to that threshold optimizes tax efficiency. Market conditions also matter; converting when account values are lower reduces taxable amounts while allowing future tax-free growth.

The five-year rule requires converted funds to remain in the Roth IRA for at least five years before penalty-free withdrawals. Each conversion has its own five-year clock. Additionally, those nearing RMD age must take their required distribution before converting any remaining funds, as RMDs themselves cannot be converted.

Missed Distribution Penalties

Missing an RMD results in penalties. The SECURE 2.0 Act reduced the penalty from 50% to 25%, and further to 10% if corrected within two years.

To correct a missed RMD, the account holder must withdraw the required amount as soon as possible and file IRS Form 5329 to request a penalty waiver. The IRS may grant leniency if the failure was due to reasonable error and corrective action has been taken. Common reasons for missed RMDs include administrative mistakes, miscalculations, or confusion over aggregation rules. Automating distributions or working with a financial advisor can help prevent these errors.

Qualified Charitable Distributions

Qualified charitable distributions (QCDs) allow retirees to reduce the tax impact of RMDs while supporting charitable causes. Individuals age 70½ or older can donate up to $100,000 per year directly from an IRA to a qualified charity. These distributions count toward RMDs but are excluded from taxable income.

Reducing adjusted gross income (AGI) through a QCD can help lower Medicare premium surcharges and may reduce the taxation of Social Security benefits. However, QCDs must be made directly from the IRA to the charity; withdrawing funds first and then donating them does not qualify for the tax exclusion. Donor-advised funds and private foundations are not eligible recipients, so retirees should verify that their chosen charity meets IRS requirements.