Having to take a required minimum distribution, or RMD, can be a big drawback to owning a 401(k) or individual retirement account. Federal law requires a retiree who turns 70 1/2 to withdraw a minimum amount every year, based on her age and the account size, and report it as taxable income. The options for avoiding RMDs are few, and it's possible you'll just have to bite the bullet and withdraw.
Rolling over your account to a Roth IRA is the only way to completely duck RMDs. You pay tax on contributions to a Roth, including the rollover, but you never make RMDs, and any withdrawals you do make are tax free. The Charles Schwab firm says if you want to leave the account to your heirs, this can be a good strategy. It can, however, be a costly mistake if your tax rate when you roll the money over is higher than when the RMDs start. It's often smart to consult a financial professional first.
Delay While Working
If your retirement account is a 401(k) and you choose to stay with your employer after turning 70 1/2, you don't have to touch the account. When you finally leave -- for whatever reason -- the RMDs start. This only applies if the terms of the company plan allow it. If the plan rules say you take RMDs even while employed, you have to take them. You also have to take RMDs if you own more than 5 percent of the business.
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Withdraw Extra Each Year
The RMD is a floor, not a ceiling. If you're in a high tax bracket, the "New York Times" says, it may be worth withdrawing extra each year. This won't count toward next year's RMD, but as you'll have a smaller account, the RMD will be smaller. That can work out well if, for example, you're right on the cusp of having to pay alternative minimum tax. If you're confident you'll pay the same tax rate this year and next year, there's no particular benefit to this approach.
The First Year
The year you turn 70 1/2 is a special case. Rather than take an RMD that year, you can postpone it until April 1 of the next year. In that second year, however, you'll have to take two RMDs. If your account is doing well, the "Times" says, it might be worth allowing for more months of tax-deferred asset growth, provided it won't push you into a higher tax bracket the next year. You may want to wait until December of the first RMD year to see what taxes for next year will be like.
- Internal Revenue Service: Traditional IRAs
- Internal Revenue Service: Roth IRAs
- Charles Schwab: Roth IRA Conversion: Does It Make Sense?
- Internal Revenue Service: Retirement News for Employers -- Spring 2012 -- We're Glad You Asked! -- Required Minimum Distributions
- New York Times: Looking to 70 1/2, a Magic Number in Retirement Plans
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