Think Outside the RMD Box

I’ve spoken with many folks who retire from work or sell a business, enjoy the uncommitted time for a while, then express regrets over leaving a year, three years, or five years down the road. “If I had known my health would be good…”

Consider a hybrid retirement. Or a phased exit from your business. This option helps answer personal questions and readiness questions, but it also opens the door to interesting Required Minimum Distribution (RMD) planning.

At age 73 (or another age for you), the IRS rings the dinner bell and requires distributions from pre-tax retirement accounts. For many retirees, RMDs are a welcome retirement income, needed or enjoyed for a special vacation, purchase, or home improvement. They help pay the bills.

But for people who do not need the income, RMDs can feel like forced taxable income at the wrong time. They increase taxes on income and potentially your tax bracket, Medicare premiums, Social Security, net investment income tax (NIIT) and maybe more. RMDs end growth on funds. That is why good RMD planning can make a material difference. It starts with the question: “Do I have to take this distribution now, or do I have options?”

You do. One overlooked strategy is the “still-working” exception. If you keep working past age 73, you may be able to delay RMDs from your current employer’s 401(k) plan until the year you retire. But there are cautions. First, this applies only to the current employer’s plan, not IRAs and not old 401(k) plans. Second, it does not apply if you are more than a 5% owner of the company sponsoring the plan. Third, the plan document matters. The IRS may allow the exception, but the plan itself must permit it.

Imagine your phased retirement. You like your work, but you no longer want a 40-hour week. Your employer allows you to stay on payroll working eight hours per week or another number. There is no special federal “eight-hour rule,” but if the plan treats you as an active employee and allows the still-working exception, that modest work schedule might defer RMDs.

Assume you have $500,000 in your current employer’s 401(k), earn 5% annually, and defer RMDs for five years. Without the exception, estimated RMDs from ages 73 through 77 would total about $104,000. At a 24% marginal federal tax rate, that is roughly $25,000 of tax not paid during those years. Meanwhile, the money left in the plan continues to compound. With deferral, the account could grow to about $638,000 after five years. Without deferral, after taking annual RMDs but still earning 5%, the account might be closer to $524,000.

These are only examples and not to be relied upon for your situation. RMD rules are technical and depend on the account type, plan document, ownership status, employment status, beneficiary rules, and the taxpayer’s overall income-tax situation. Consult your advisor.

This is not tax magic, just tax timing. RMDs do not disappear. They are pushed into the future, and future RMDs may be larger. That could be good, bad, or neutral depending on future tax rates, health, cash needs, Medicare premiums, and estate goals.