Tax Deferred Accounts, Tax-Free Accounts and RMDs

For some individuals, when they start retirement, they may have to start making withdrawals from their IRA’s out of need.

However, other retirees have a sufficient amount of money that they do not need to touch their savings for quite some time. However, there is time that comes where they are forced to take money out, whether they need it or not.

When a retiree becomes 70 and a half years of age, they have to start taking required minimum distributions (RMDs) from their retirement accounts.

The IRS enforces these distributions so that the government can finally take it’s cut of the money you have been growing years, if not decades. The government does have services, programs, and debt to pay as well.

The IRS states that findings in these accounts cannot always be untouched.

For those that are considering not to anyway, will have to pay a 50% penalty on the mandatory balance that is not withdrawn. Those that wish to take more than what it required can do so.

The only times these RMDs decline is when the market crashes, or if a retiree has permanent nursing care or incredibly high-cost drugs, they need to pay for as these medical deductions will cover these required distributions.

Because money from a traditional IRA can increase value tax-free, this is a big reason as to why RMDs are required on such accounts.

Starting next year, there will also be a higher maximum contribution limit for an employer-sponsored retirement savings plan. Those that have a 401(k), 403(b), or a 457 (most are eligible) plan, or a TSap, they will have a cap of $19,500, a $500 increase.

A Roth account as a yearly cap of $6,000 with an added $1,000 for those that are eligible for catch-up contributions. To be eligible, you must be age 50 or older.

Keep in mind that Roth accounts also have a limit on how much you can make to be able to contribute.

However, because Roth accounts are invested with after-tax money, withdrawals made during retirement are not subject to income tax. This is why RMDs are not mandatory on such accounts once you reach 70 and a half.

Traditional IRA’s are invested with pre-tax dollars, which lessens your taxable income on the year you have the money withheld into your IRA. When you take money from these accounts during retirement, you will be facing taxes at the current rate of when you make a withdrawal.

There is a Roth 401(k) plan that is becoming more common within employer-sponsored retirement plans, where the yearly contribution limit is the same as a traditional 401(k). However, you still use money that has already been taxed, and this type of account does need to have RMDs taken when 70 and a half.

Because there are such differences in how tax is treated on all these accounts, many people wonder what kind of saving plan they should contribute to.

Many financial professionals will say that contributing to a tax-advantaged retirement account is a smart decision for the majority.

A prime motive to put money into a Roth is because of the money increase in value without being subject to income tax. Another is because required minimum distributions are not mandatory in this type of account. Also, contributions made can be touched without being subject to taxes or penalties, which means that your Medicare B premiums surcharges or Social Security taxation limits will not be affected.

For those that are contributing to a traditional tax-deferred IRA, be sure to focus on making investments with tax efficiency in mind. Such funds that would qualify would be municipal bond funds/ETFs or broad market index funds/ETFs.

Those that are under 70 and a half may want to consider yearly partial Roth conversions to diversify their taxes. These conversions may be taxes a lower rate compared to after you are 70.

Now, in regards to RMDs, though some see it as a bad thing, it may not be as bad as they think as a majority of traditional tax-deferred accounts have tax deductions on the contributions, which then has the investments grow tax-free in a computer manner. The advantages of this growth can be underrated, as this can significantly increase your investment value.

However, be sure to diversify your taxes if a significant portion of your savings is in these kinds of IRA’s with partial Roth conversions before they are 70 and a half.

It is very important to plan for RMDs way before it is required so that you can strategize and act accordingly.

For those retired that do not wish to have their RMDs included in their earnings, they may want to make a qualified charitable distribution directly from their retirement savings account. They can donate to $100,00 every year.

The choice of contributing to a traditional IRA or a Roth is based on timing and taxes. If you expect to have a lower tax rate in retirement, traditional tax-deferred accounts may be ideal for that situation. For those that anticipate being taxed at a higher rate than now, investing in Roth may be in your best interest.

However, since anything can happen in the future, it is better to diversify your investments and taxes, which can provide more stability and mobility during retirement.