Why Waiting Until 73 to Plan for RMDs Could Cost You

For many retirees, turning 73 brings a new and unwanted financial milestone – the start of required minimum distributions, or RMDs. If you have your retirement nest egg in a traditional IRA or 401(k), you’ll be forced to take RMDs beginning that year or otherwise risk a pretty substantial penalty on whatever funds you don’t withdraw from your savings on time.

You might think RMDs aren’t something to worry about until you actually turn 73. But it’s a much better idea to plan for them in advance.

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The problem with RMDs

The reason RMDs exist is because the IRS eventually wants to collect taxes on retirement savings that have been growing on a tax-deferred basis. Also, the IRS doesn’t necessarily want IRAs and 401(k)s to serve as wealth transfer vehicles.

RMDs are calculated each year based on your account balance and life expectancy. They’re due by Dec. 31 each year, and you’re penalized 25% of whatever funds you don’t withdraw by that deadline.

For some people, RMDs aren’t an issue. It’s not a big deal to be forced to take a withdrawal from your IRA or 401(k) if that was already part of your plan.

Rather, issues arrive when you don’t need your RMDs, or when you don’t need to withdraw as large a sum as your RMDs call for. That’s because RMDs are taxed as ordinary income, so between those withdrawals and Social Security benefits, you could find yourself pushed into a higher tax bracket than you want to land in.

And speaking of Social Security, RMDs could also drive your income up to the point where those benefits become taxable. RMDs could also push your income high enough where you’re assessed surcharges on your Medicare premiums known as income-related monthly adjustment amounts.

That’s why it’s not a good idea to wait until age 73 to start thinking about RMDs. Even though you’re not on the hook for taking them until then, planning for RMDs ahead of time could minimize some unwanted tax consequences.

Strategies to minimize RMDs

With proper planning, you may be able to reduce the amount of money you have to withdraw in RMD form, or even avoid RMDs altogether. But to pull that off, you may need a multi-year strategy.

One option is to do Roth conversions in the years leading up to age 73. But Roth conversions count as income and could drive up your tax bill each year you do one. For this reason, it’s best to spread Roth conversions out over many years if possible.

Another option is to strategically draw down your traditional retirement accounts over time so that by the time you turn 73, your RMDs aren’t so substantial. Remember, your account balance helps determine what RMDs you have to take alone with your life expectancy. So the smaller your IRA and 401(k) balances are, the less burdensome RMDs might be.

Although RMDs don’t begin until age 73, waiting until that point to deal with them is a mistake you might regret. A better approach is to come up with a years-long strategy to minimize the blow of RMDs so you’re not left scrambling once your 73rd birthday arrives.