What retirees can do right now to reduce next year's taxes
Withdrawing money from retirement accounts will have consequences on your 2024 return.
You’ve only just finished preparing your 2023 taxes — or you're close to being done. Since taxes are top of mind, it’s a good idea to start planning for next year’s return.
How you manage your retirement accounts in 2024 will have a direct impact on the tax bill you’ll face next April.
A surge in retirement account balances last year has started to roll out for retirees who are already taking their required minimum distributions (RMDs) from IRAs and workplace plans. Your RMD is generally taxed as ordinary income in the year it’s taken, so the taxes on that money will come due next April.
“The year-end retirement account balance, though, is key to retirees because their required minimum distribution is based on that balance,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance. “So the first thing they're going to see is larger RMDs this year.”
While more income via bigger RMDs sounds like good news, it’s vital that you manage those withdrawals wisely so you don’t get a surprise at tax time.
Here are a few moves you can make to stay ahead of the game.
Read more: 3 ways retirees can save on taxes
Nuts and bolts of RMDs
The amount you are required to withdraw is calculated by dividing your tax-deferred retirement account balance as of Dec. 31 of the preceding year by a life expectancy factor that corresponds with your age in the IRS Uniform Lifetime Table.
As your life expectancy declines, the percentage of your assets that must be withdrawn ramps up. Of course, you can withdraw more than required, but that distribution in excess doesn’t count toward your required amount for future years. More on that shortly.
If you have multiple retirement accounts, you’ll need to suss out your RMD for each one individually.
One exception that may let you delay your RMD from an employer-sponsored 401(k) or (403(b) plan is to stay on the job.
Getting help with RMD calculations
A tax professional can help you figure out the amount you must take annually, or you can use an online calculator such as the one AARP provides or the one Fidelity has on its website. The IRS also provides worksheets.
Most financial services firms will calculate your RMD for you, which can streamline the process for you.
Typically, your provider will alert you in January about what your required amount will be for the coming year, and you can choose to have your withdrawals stretched out over the year. Say, for example, you have a $40,000 mandatory distribution for 2024, you could schedule a monthly withdrawal of roughly $3,333.
It’s generally a good idea to automate your withdrawal so you avoid the penalties of forgetting to take it or miscalculating the amount required for you to take.
Under a new law, starting this filing season, seniors who fail to take the required minimum distribution will pay a penalty of 25% on the amount. But if you correct your mistake usually within two years, the penalty could be reduced to 10%.
The penalty may also be waived entirely if you can make the case that the mistake in distribution was not your intention and you’ve taken action to correct it.
Some plan providers and custodians allow you to set up automatic withdrawals, based on the same criteria of age and year-end account balances, with the proper amounts calculated and then withdrawn and sent to you by check or direct deposit on the date you select.
You can also have taxes withheld in advance. If you don’t, make certain you set aside funds to cover that bill.
And keep in mind that just because you have to pull the money out of a tax-deferred plan doesn’t mean you can’t reinvest it in a non-retirement account after you’ve paid that tax on the distribution.
“It really shouldn’t be this hard to take money out of your retirement account,” Slott said. “It is hard to figure out even for experts. It's insane.”
Consider making charitable contributions
Knowing your RMD for the year can be an opportunity to take advantage of the Qualified Charitable Distribution, Slott said.
These charitable distributions from your retirement accounts count toward your RMD, and you can exclude them from gross income up to $100,000 annually.
One caveat: 1099 Forms do not show that the distribution was given to charity. As the IRA owner, you need to communicate with your accountant and make sure they know not to include the distribution in income.
The transaction must be done by the end of the tax year. You can have your custodian or retirement plan administrator send the withdrawal directly to a qualified nonprofit, which keeps it off your individual tax return.
“You do it because you want to give to the charity or nonprofit cause,” Slott said. “If you're giving anyway, the money in your IRA is the best to give to charity because it’s loaded with taxes. The only negative is it's not available to enough people.”
The QDC is available to IRA holders who are age 70 1⁄2 or over when the distribution is made, per the IRS rules.
“Most people don't think of making gifts until December when they’re feeling the holiday spirit, and that's too late,” Slott said. “If you do the QDC right now in January, at the beginning of the year, it can offset your RMD for 2024.”
Double hit in 2025
For those of you who turn 73 this year, the jig is up. For decades, you’ve been squirreling away retirement savings, allowing them to grow tax-free. Now it's time to start pulling some of that nest egg out.
Don’t panic. You have to take your first distribution by April 1, 2025.
But there is a catch. Your next RMDs must be completed by Dec. 31 of the year and every year after. What that means is that if you opt to hold off on that first distribution until next April, you will likely have two distributions to take next year. Both distributions will be reported on your 2025 federal tax return, and that may seriously boost your taxable income.
“For most people, it's best to take the one for 2024 by the end of this year,” Slott said.
Taking more than the RMD 'minimum'
For tax reasons, it's also a good idea to take more than just what you're required to withdraw.
“You should be looking at how to get the most out, not the minimum,” Slott said.
The marginal tax rate in 2024, for example, is 24% for incomes over $100,525 ($201,050 for married couples filing jointly). A decade ago, it was around 28%.
“People who don’t really need the money complain that it stinks that they have these required minimum distributions, but my message is the opposite,” Slott said. “Guessing what future income tax rates will be is quite a large gamble. The key to keeping more of your hard-earned money protected from taxes is to always pay taxes at the lowest rates, which may be right now.”
Over the long haul, those taking the tiniest amount they possibly can will probably end up paying more in tax, according to Slott’s math.
“If you want to have more later on for retirement, the only way to do it is pay less in taxes,” he said.
Meanwhile, only taking the minimum required can create a nasty situation if you are leaving your retirement fund stash to your heirs. Under the new rules that started this year, they now need to empty inherited IRA distributions within 10 years.
That can mean a sizable tax bite for them. Chances are they will inherit when they’re probably in the highest tax bracket of their working life amid their peak earning years.
Roth conversions
The most audacious move along these lines is to consider doing what’s called a Roth conversion. That means shifting pre-tax investments, such as those in an IRA or a 401(k), paying the tax, and putting the money into a Roth IRA. Then when you make withdrawals from the Roth, the money comes out tax-free.
When many people retire, they’re in a lower tax bracket. "This gives people a window of time to do this conversion when their tax bracket is better under their control," Jeffrey Mellone, an executive wealth management adviser with TIAA, told Yahoo Finance.
Balance withdrawals from retirement and non-retirement accounts
Retirees can also save on taxes by divvying up the accounts they pull from for living expenses.
“It might make sense for you to balance withdrawals, taking out some money that’s already been taxed and some money that hasn’t,” Mellone said. “This may seem counterintuitive, but depending on your income bracket after you retire, paying taxes now on some withdrawals could, in turn, reduce the size of your RMDs later.”
Kerry Hannon is a Senior Columnist at Yahoo Finance. She is a career and retirement strategist, and the author of 14 books, including "In Control at 50+: How to Succeed in The New World of Work" and "Never Too Old To Get Rich." Follow her on X @kerryhannon.
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