Happy 60th Birthday. Time to Reduce Future RMDs.

Traditional retirement accounts are "unlocked" at age 59.5, opening a window to act before RMDs start at 73.

Many clients spend decades accumulating income to fund living expenses during retirement. For most, those retirement funds are locked into traditional retirement accounts during the client’s working years.

While advisors pay significant attention to making sure that clients maximize the value of pretax retirement contributions during those working years, it’s also common for clients to start paying less attention to individual retirement account planning options as years go by. That’s often because those funds are “locked up” and, with any luck, in growth mode during working years. 

Once clients reach their 60s, however, it makes sense to start exploring the options for their IRA balance. That’s because traditional retirement accounts are “unlocked” once the client reaches age 59.5 — and some clients may benefit from taking action sooner rather than waiting until age 73.

As with any tax reduction strategy, clients should be aware of the pros and cons before proceeding. For those interested in reducing future RMDs, the mid-60s may be the prime time to act.

Why the 60s Matter

Before clients turn 59.5, they’re generally unable to access traditional retirement funds. Unless they have experienced a hardship or qualify for another exception, the 10% early distribution penalty will apply in addition to ordinary income tax rates. 

Once clients reach 59.5, however, they can access retirement funds without penalty. While ordinary income tax rates will still apply to any distributions of pretax contributions, tax rates are relatively low since the 2017 tax overhaul.

So, clients are able to access their retirement funds without penalty but aren’t required to start withdrawals. Once they turn 73, the current required beginning date, they must start taking annual distributions based on their life expectancy and account balance.

If clients withdraw less than the amount required, they’re hit with a penalty equal to 25% of the missed amount. It’s 10% if the client takes the missed RMD, files a return and pays the required tax within two years of the original due date for the missed RMD.

Pre-RMD Options

During their 60s, clients have the maximum amount of flexibility to engage in strategic planning with their IRA and 401(k) funds. They have many options. 

Clients with large account balances may wish to examine their tax situation and start taking money out early. By reducing their balance before hitting the required beginning date, they may be able to lessen the amount of their RMDs during retirement — and cut their associated post-retirement tax liability.

Of course, this strategy makes sense only for clients who have stopped funding traditional retirement accounts during their 60s.

For other clients, it may be time to explore a Roth conversion. Converting traditional retirement funds to a Roth does generate current tax liability, but tax rates are at relatively low levels — and it’s impossible to know whether they’ll be higher when clients have no choice but to take taxable distributions.

The converted amounts must be tied up in the Roth for five years to give the client the maximum benefits of the account. 

However, clients will have created a tax-free income source to draw upon during retirement and, simultaneously, trimmed their traditional IRA balance while reducing the amount of taxable RMDs during retirement. This diversified approach allows them to draw from different sources during retirement to both minimize tax liability and make sure their needs are met.

When clients are considering tapping their traditional IRA before reaching age 73, they should also be paying attention to the Medicare income-based surcharges. Taxpayers become subject to the income-related monthly adjustment amount (IRMAA) when their income exceeds certain thresholds. A two-year lookback period applies.

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