Last year’s strong market performance means this year’s required minimum distributions (RMDs) are likely to rise for many retirees. For some, that’s good news. For others, not so much.
Here are advisors’ suggestions for how to best prepare, whatever your client’s situation.
How RMDs Work
RMDs, of course, are the amount of money people 73 and older must withdraw from their tax-deferred retirement accounts by year’s end. (Note: The RMD age increased this year.) These distributions are calculated by dividing a retirement account's returns at the end of the previous year by the account holder’s current life expectancy.
“The life expectancy factor decreases every year, so that—combined with a larger year-end balance—means higher RMDs,” explained Kevin Brady of Wealthspire in New York City. He added that the S&P 500 was up roughly 24% in 2023 while U.S. bond markets rebounded more than 5%.
To be sure, some clients won’t face a distribution increase. “For those who were heavily weighted in tech or in index funds, the gains may be much larger than those who were heavily weighted in value stocks,” noted Jennifer Kim of Signature Estate & Investment Advisors in Los Angeles.
But after 2023’s robust returns, “you would be hard-pressed to find someone with a smaller distribution in 2024,” said Dustin Wolk at Crescent Grove Advisors in Milwaukee.
Differing Opinions
Advisors say that some clients should be celebrating. “A higher RMD is good news for everyone—individuals, households and the local economy,” said John McCafferty, director of financial planning at Edelman Financial Engines in Alexandria, Va.
The other side of the argument: “RMDs are never good news,” said Dean Catino of Monument Wealth Management, who’s also based in Alexandria, Va. “By definition, the account owner is being forced—required—to withdraw from their retirement account, and that withdrawal [comes] with taxes at ordinary tax rates.”
However, he added, it’s important to remember that the retirement accounts have been growing at a compounded, tax-deferred rate “often over several decades. Now that is good news!”
The Good News
For clients who use their required minimum distributions to help pay for living expenses, this year’s increase is a bonus. “RMDs can be used in positive ways, like reducing debt, building cash in the emergency fund or investing the excess,” said Chris Briscoe at Girard, a Univest Wealth division, in King of Prussia, Pa.
The higher distribution signifies that a client’s retirement accounts have “recovered a good amount of the assets they withdrew the prior year,” said Matthew Pastor at Johnson Brunetti, an Alera Group company, in Hartford, Conn.
The Bad News
But the extra cash can also be a problem, especially for “people who have other income and do not need all of the RMD to finance their lifestyle,” said Bob Schneider of Johnson Financial Group in Milwaukee.
It will push some of these clients into a higher tax bracket. Not only could it trigger higher taxation of Social Security benefits, explained Aaron White at Adero Partners in Pleasanton, Calif., but it might force a surcharge on future Medicare premiums, which are based on past income.
“For affluent clients, the burden is more pronounced … potentially exposing them to the 3.8% surtax on investments,” White continued, referring to an extra tax on net investment income for those whose modified adjusted gross income exceeds $200,000 (or $250,000 for married couples).
Lower income clients could suffer, too. “The additional income may impact their ability to qualify for subsidies for health insurance or reduced property taxes,” said Mike Kazakewich of Coastal Bridge Advisors in Westport, Conn.
What’s more, the bigger withdrawal decreases the client’s total retirement portfolio and its future growth potential.
QCDs
But advisors insisted that careful planning can help clients be better prepared.
One option for reducing the taxes on high RMDs is to use qualified charitable distributions, which allow you to transfer withdrawals from a retirement account directly to 501(c)(3) charities. This year, the limit on such transfers has been raised to $105,000.
Up to that amount, you can “gift the entire RMD to eliminate its tax consequences,” said Bradley Newman at Fort Pitt Capital Group in Harrisburg, Pa. The funds don’t count toward a client’s adjusted gross income and won’t trigger Medicare surcharges or the 3.8% tax on investments for wealthy clients, he said.
Qualified charitable distributions can be made from IRAs by anyone who is 70½ or older, he added, and can therefore be used to reduce IRA balances before required minimum distributions go into effect.
Roth Conversions
Another strategy is to convert some retirement-account funds to Roth IRAs. You have to pay income tax on the conversion, because Roths are funded with after-tax dollars, but the move will reduce the size of the retirement accounts and therefore the size of future required minimum distributions—but only future RMDs, not current ones, said advisors.
“Roth conversions require paying more taxes up front,” said Kelly LaVigne at Minneapolis-based Allianz Life Insurance Company of North America. “But you can’t use RMD money for Roth conversions, so it needs to be done before RMD age to be really effective.”
Clients should only pursue this option if they have “access to outside, after-tax funds to cover the tax burden,” cautioned Matthew Spradlin at Steward Partners in Midlothian, Va.
And this year isn’t the best time for Roth conversions—they’re best done in lower RMD years, said Scott Benner of KBBS Financial in Seattle. High-distribution years like 2024, in fact, show how such conversions smooth taxation over five to 10 years, he said.
Kristina Mello at StrategicPoint Investment Advisors in Providence, R.I., concurred. “Roth conversions are ideal for reducing future taxes when looking ahead at large RMDs,” she said. “The opportunity for these occurs during the sweet spot after a client retires but before RMDs kick in.”
In other words, plan ahead. “This high RMD year really highlights how important it is to spend some time planning around current needs and future needs,” stressed Ben Rizzuto at Janus Henderson Investors in Denver.
Special Circumstances
There are a few other special circumstances that may affect clients’ required distributions.
“Those still employed are exempt from taking RMDs from their employer’s plan [unless they own 5% or more of the business] but are still required to take the RMD from any IRAs,” said Angie O’Leary of RBC Wealth Management in Minneapolis-St. Paul. In some cases, she said, you can “roll over other tax-deferred accounts into your employer’s 401(k).”
Another consideration is whether the required distributions come from inherited IRAs. According to the SECURE Act 2.0, all funds in inherited IRAs must be fully distributed by the end of the 10th year after the original owner’s death, unless the heir is a spouse, a minor dependent child, disabled, or otherwise determined to be an eligible designated beneficiary. (If the original owner’s death occurred in 2019 or earlier, the funds must be withdrawn within five years.)
“There is confusion, however, as to whether there are RMD requirements before year 10,” said Lisa Featherngill of Comerica Wealth Management in Winston-Salem, N.C. “The IRS is supposed to provide guidance this year.”