IRAs and 401(k)’s Are Good Now, But Will RMDs Hold You Back Your Retirement?

Most people adjust throughout their working lives to save as much as possible for retirement and be wise investors.

Unfortunately, most people carelessly put their money into tax-deferred retirement accounts, such as traditional independent retirement accounts or employer-sponsored 401(k)s. This approach helps them save on taxes during their working life, and is an effective way to make savings. But it is not in their best interests, as they reach their 50s and 60s, to continue to voluntarily contribute money to their IRAs and 401(k)s.

why? Because of the tax ramifications in retirement and minimum required distributions (RMDs). It is critical, long before retirement, that people take a look at the strategies that will reduce their tax burden when they retire. Because it’s not about all the money you make in your working life, but about how much you can keep.

Defuse your RMDs with Roth

RMD can be a time bomb for some people of retirement age. They are required of many retirees—even if they don’t need the money at the time—who have a traditional IRA or 401(k) and those with other qualifying plans, such as 457(b), 403(b) or simplified employee retirement ( SEP) IRA. Some people, when looking to retire, think they will be in a lower tax bracket, but RMDs, especially when added to Social Security payments and other income, may actually put them in a higher category.

The 2019 Safety Act raised the age required to start taking RMDs to 72 from 70°C; People with any of the above accounts must start withdrawing money from their retirement account by April 1 of the year after they turn 72. In subsequent years, they must withdraw the RMD by December 31, based on the calculation of the RMD. Failure to take a person with RMD results in a fine of 50% of the RMD amount in that year.

But making contributions to a Roth IRA or a Roth 401(k) or making regular annual transfers to Roths from your existing tax-deferred retirement accounts are effective ways to generate tax-deductible income in retirement and reduce — perhaps significantly — your tax burden in those years. golden . With Roth, you pay taxes up front each year when you contribute to the account, but investment growth and account withdrawals in retirement are tax-free (as long as you’re 59 or more and have owned a Roth account for at least five years). That’s a big difference from traditional pre-tax savings accounts, like a basic 401(k) or IRA, where you get a tax break each year for your contributions but pay taxes later when you start withdrawing money at retirement.

In addition to the tax savings for a Roth on the back end, in retirement, there are other benefits. While Roth 401(k) accounts are subject to the same RMD rules as traditional 401(k) accounts, you can transfer a Roth 401(k) account to a Roth IRA, which is not subject to RMD rules. Roth savings can also help reduce Medicare Part B annual premiums, which are based on taxable income. Roth withdrawals are considered tax-exempt income, so withdrawing money from them can prevent an individual’s annual income from exceeding Medicare thresholds.

Since many people have many, if not all, of their retirement funds in their traditional 401(k)s or IRAs, strategizing with a financial professional to make annual Roth transfers can be a wise move. There is no limit to the amount of money you can transfer or move from an eligible account to a Roth account. However, there are annual limits to how much you can contribute to a Roth IRA — up to $6,000 in 2022 ($7,000 for those 50 and older) — as well as contribution limits based on family income and enrollment status. You can contribute a maximum of $20,500 to a Roth 401(k) in 2022, like a traditional 401(k) contribution (and an additional $6,500 as a compensation contribution if you’re 50 or older).

Gaining popularity – at least among employers

Many employers have added a Roth 401(k) option; The share of 401(k) plans offering Roths jumped 75% over a decade ago, to 86% in 2020. But according to Plan Sponsor of America Council, only about 26% of workers saving in their 401(k) plans used a Roth option in year 2020.

It’s important that people benefit from a Roth 401(k) fairly soon in addition to a traditional 401(k). why? Roth makes more sense to many people now because the next four years offer a rare opportunity to take advantage of the relatively low tax rates stemming from the Tax Cuts and Jobs Act of 2017, which expires at the end of 2025. Some avoid Roths because they believe their tax bracket will be lower In retirement, however, this is not always the case, and tax rates will likely start to rise anyway once the TCJA expires. And who knows how much higher it will be in the future, given the trillions of dollars the government has spent helping individuals and businesses through the pandemic.

The conclusion is: Many people and accountants focus on saving in taxes in a given year. Individuals and professionals who help them with finances need to focus more on advance tax planning that will help them tremendously in the years ahead, especially in retirement.

Pay more taxes now while the rates are lower than they will be in the future. Enjoy more of the fruits of your labor in retirement by taking advantage of Roth.

Dan Duncan contributed to this article.