How to Avoid Taxes on Your Required Minimum Distribution
You cannot avoid taking required minimum distributions from your retirement accounts once you reach the age where they kick in but you can avoid having to pay tax on them if you use them to support the causes that are important to you.
Speaker 1 (00:07):
Welcome back to 30 Minute Money, the podcast that is dedicated to delivering action items, smart money ideas, and little bite sized pieces. I'm Scott Fitzgerald from ROC Vox Recording and Production, and joining me in studio is Steve Wershing from Focused Wealth Advisors. Hey Scott, the man with the plan,
Speaker 2 (00:26):
The man with lots of plans, the man's
Speaker 1 (00:27):
With lots of plans, and nice to
Speaker 2 (00:28):
See you again.
Speaker 1 (00:29):
Good to see you too as well. And, um, today we're gonna be talking about one of my favorite subjects is Avoiding Tax , avoiding Tax, uh, but this is specifically avoiding tax on your rmd. And for those of us, uh, who don't know what that is, what is an rmd? So
Speaker 2 (00:44):
An RMD is a required minimum distribution. So if you are putting money into a tax deferred account, four [inaudible] ira, 4 0 3 bk, any of those kinds of things, um, it's a great deal. It can be a great deal to put off taxes for a while, but at some point the IRS will come back and say, okay, we've let you do this long enough, it's time for us to start getting some tax taxes on that money. And so, um, they will require that you start taking out a certain minimum amount from your accounts each year. And, uh, if you haven't planned for it, then that can be a really rude surprise. It's, you know, it, one of the challenges that we have is when people put, if people follow the advice of guys like me and put lots and lots of money into these tax deferred accounts, you can actually inadvertently set up a trap for yourself.
We call it the time bomb, where, you know, if, if you, if you save lots and lots of money into these tax deferred accounts and you're a good little saver and, and it's been working hard for you and it's growing and growing, and then you retire and you've got a fairly frugal lifestyle, so you've got some social security, maybe you have a pension, you're taking some distributions from your retirement account, you may end up in a situation where all of a sudden, whether it be 73 or 75, um, the government's gonna come back and say, well, okay, it's been long enough. Now we're gonna require that you take a certain minimum amount and that might be a lot more than you need and a lot more than you were planning on. And all of a sudden you get this big tax bill because, um, because there are these formulas that the government ha applies and they're based on your age and your life expectancy.
And for a number of folks, that's enough to push their tax bracket up by a, a full bracket or two or more if they've got a lot of money in these deferred accounts. So, um, so the a a lot of the planning that we do is, is, is to try to make sure that people do not get, get hit by that unexpectedly, and that, that they don't have to pay more tax on it than they absolutely need to so that they don't get these huge required minimum distribution requirements, um, that push them up in their tax back, uh, bracket. So the, of course, the best strategy is avoidance. The best strategy is planning. And what that means is systematically taking money from your deferred account and figuring out how to migrate it over to a tax-free account over the course of time. Uh, but you know, you can only accomplish so much of that at a time.
It's a little bit like vitamins, you know, it, it only works if you take a little bit at a time over a long period of time. You can't expect to take 10 years worth of vitamin C all at once and expect that's gonna have a, that's gonna get you where you want to go. Um, so ideally what we would do is systematically balance those tax buckets, the tax deferred accounts, the tax free accounts, and the taxable accounts over the course of time. From my perspective, the ideal is when you get to the point where the required minimum distribution is exactly the standard deduction, because if you can get to the point where those two balance each other, then effectively you don't pay any tax on that required minimum if you can. If you're forced to take a certain amount and that's exactly how much that you, that you can claim as a, as a standard deduction, then the two kind of cancel each other out. But many people can't get to that point, and so they have to take some RMDs. But there is a strategy that you can use to not get taxed on those distributions. And it's called the Qualified Charitable Distribution or a qcd,
Speaker 1 (04:23):
The Man with all the great little acronyms and, and what was it? What's that thing you say
Speaker 2 (04:28):
All the time? Yeah, the consultants love our TLAs, our three letter acronyms. So three
Speaker 1 (04:31):
Speaker 2 (04:31):
Gonna hear lots of TLAs on this podcast, .
Speaker 1 (04:34):
So when can you use a qualified, uh, charitable dis, what was it? Qualified charitable distribution?
Speaker 2 (04:39):
Yeah, so you can use a qcd, um, if you, if you don't need the money, if, if, if you are, uh, contributing to charitable causes anyway, you can take what otherwise would be a required minimum distribution. You can send it directly to a charity and that way it's not taxable. You've taken it outta the account, it satisfies your RM, potentially satisfies your RMD requirement, but you don't have to pay tax on it. So as an example, there's a, a good example, you know, right from, from some clients of mine, um, and they are Christians and they tithe. And so tithing is, um, you know, there are certain, certain religious sites that believe that, you know, it's their obligation to contribute a certain amount of what they make every year to the church. And so what they're expected to donate, what they're committed to donate is a specific percentage.
And so I had some clients and they were coming up on their required minimum distribution date. And so we were looking for ways of trying to avoid the taxation audit and they tithe. And so, um, actually this, this was suggested by the, by the couple's accountant. It wasn't, you know, it, it, I hadn't even gotten to it yet. And he called and said, Hey, can they, can they use a QCD for their tithe? Absolutely, they can, as long as your church is a charitable organization. Um, then they were, they were contributing this money anyway because it's part of their belief. And so we just did it a different way. We just distribute, we just donated it a different way. And instead of taking it out of their bank account like they normally would every month, we took it out of their ira, classified it as a qcd and that satisfied that much of their required minimum distribution and that part of it they did not have to pay any tax on.
Hmm. Now there are some rules around that. First is you have to be 70 and a half you, it doesn't, you know, you're not allowed land allowed to do it below that. Now, it used to be that your required minimum distributions kicked in at 70 and a half. So this is part of one of the interesting things about how the tax code can get uncoupled in a certain way, that because of the secure act and now the secure Act 2.0, you can defer required minimum distributions until 72 or 73 or 75, but you're still eligible to make a qualified charitable distribution when you're 70 and a half because they didn't update that part of the code. So if you're trying to take money out of your retirement plan and you're 70 and a half, so you don't have to take required minimum distributions yet, you can still take a QC d and start draining off, you can start reducing the amount of those deferred accounts by making those charitable qual those qualified charitable contra distributions directly to the charity even before you are required to take your RMDs. And did the,
Speaker 1 (07:28):
Did the government raise the RMD ages?
Speaker 2 (07:31):
They did. So, uh, back in 2019, they passed the secure act and then a couple years later they pack passed the Secure Act 2.0 and they raised the RMD age from 70.5 to 72 at first, and then with 2.0, they raised it to either 73 or 75, depending on what year or you were born. And so, so these have now become uncoupled. So they've, you know, so you can now do, you can now do these Q CDs even before you're required to take your rmd. Now I should also add that not there, there are a bunch of rules around this. Of course, it's the tax code. So there's plenty of rules associated with this. First is that not all retirement funds are eligible. So, um, you can take money out of your ira, you can take money out of different stu types of I, uh, IRAs and use that.
But you cannot, for example, take money out of a qualified plan. So if you've got a 401k, you might have to take a minimum distribution. You cannot do a qualified charitable distribution directly from a 401k. So you, what you'd need to do is you'd need to, assuming you're no longer working for the company, you'd have to, um, roll that over into an IRA before it was qualified for a qcd. Um, there are, and, and some, if you've put, uh, some money into IRAs, that is not deductible. So if you've made a non-deductible contribution to an IRA and that was gonna be returned to you via a distribution, you can't use that as a qualified charitable distribution. It has to be a taxable distribution. So it has to be a taxable distribution from the right kind of retirement plan, largely IRAs, uh, and those are what qualify.
And then of course, there's a limit to it. So, um, you're not limited to the required minimum distribution amount. So if you were required to take, say, 10 or 15,000 out of your IRAs, you could do that whole thing into a qualified charitable distribution. But you can go beyond that too. You could take much more than that if you wanted to, up to $100,000 per taxpayer per year, as long as that taxpayer qualified. So you can actually, if you really wanted to, to take a bunch out of your IRAs so that your subsequent required minimum distributions are smaller, you can do that. And the limit on that is a hundred thousand dollars. And then the final rule, and this is really important, uh, well, actually I should say there's, there's a rule that affects this and that is that you, you have to do it before you take a required minimum of distribution.
So if you are already taking RMDs, you have to take the QC d in a year before you take your rmd. If you've already taken an rmd, you can't then take a qc d beyond that, you have to do it first if it's gonna qualify to reduce the R M D. And then related to that is the distribution has to go directly to a charity. It can't come to your bank account, and then you donate it. You have to talk to your, the, the company that holds your IRA and say, I'd like to make a qualified charitable distribution. Please take money out of my IRA and make it payable directly to this qualified charitable organization.
Speaker 3 (10:47):
Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner, Steve Woring and I specialize in helping people create low tax retirements. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family, and keep it away from the government. This free webinar will cover how taxes are different in retirement, the taxes you pay in retirement that you don't have to pay during your working life, how to move tax savings into a tax-free environment, the Widows Tax, the Secure Act, the Secure Act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot. So go to focused wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next five or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today
Speaker 1 (12:13):
Avoiding tax on your RMDs. What's your 30 minute action item?
Speaker 2 (12:17):
30 minute action item is if you are over 70 and a half, review your charitable contributions. If you are giving to charity already, you might just as well take it from your ira, reduce that balance, reduce your required minimum distributions later. So 30 minute action item. Take a look at your charitable contributions and see if the qcd is something that could save you money.
Speaker 1 (12:39):
There you have it. 30 minute.money is where you can find the podcast. Of course, we're on all the major platforms. You can find me at firstname.lastname@example.org and Steve Wershing can be found at focusedwealthadvisors.com. We'll be back next time on 30 Minute Money.