Saving for retirement is unquestionably important. Without money socked away for your golden years, you might struggle to keep up with your senior living expenses once your paycheck from work goes away and you realize that Social Security alone won’t suffice in paying your bills.
Now, you’ll often hear that it’s wise to save for retirement in a dedicated, tax-advantaged plan like an IRA or 401(k). These plans offer a number of benefits over traditional brokerage accounts, all the while letting you invest your savings for the long haul. But if there’s one drawback to saving in a tax-advantaged account, it’s that the IRS will only let you keep your money there for so long. Once you reach age 72, you’ll be required to start taking what are known as required minimum distributions, or RMDs, out of your retirement plan.
The purpose of RMDs is to effectively ensure that you spend down your retirement savings in your lifetime, rather than leave that money behind to your heirs. And while your exact RMD will be based on your life expectancy and account balance on a yearly basis, you should know that if you don’t withdraw that money, you’ll be subject to a 50% penalty on the amount you fail to remove.
So why wouldn’t you want to take your RMDs? Well, for one thing, they could increase your taxable income if they’re coming from a traditional retirement plan (as opposed to a Roth). Furthermore, once that money leaves your account, you can no longer keep it invested in a tax-advantaged fashion. As such, many seniors aim to avoid RMDs as long as possible, or even indefinitely. If that’s your goal, here are a few ways to go about it.
1. House your retirement savings in a Roth IRA
Of the various tax-advantaged retirement plans you’ll come across, Roth IRAs are the only ones where RMDs don’t apply. Even Roth 401(k)s, which work similarly to Roth IRAs, impose RMDs. Of course, not everyone can contribute to a Roth IRA directly — higher earners are barred from doing so. But one thing you can do is fund a traditional IRA and then convert it to a Roth afterward to avoid RMDs later on.
2. Work longer
Working longer won’t help you avoid RMDs in an IRA. But if you keep working for a company sponsoring your 401(k), you won’t be forced to take RMDs from it as long as you’re employed. The only caveat here is that you can’t own more than 5% of the company in question, but if you’re a regular employee with no ownership stake, extending your career is a good way to get out of RMDs a bit longer.
3. Divert more funds to a health savings account
The purpose of funding a retirement plan like an IRA or 401(k) is to ensure that you have enough money to pay your expenses when you’re older. But if there’s one expense that’s apt to climb during retirement, it’s healthcare. As such, it pays to divert some of your money to a health savings account, or HSA.
HSA funds never expire, so you can contribute during your working years, invest the funds you don’t need right away in a tax-advantaged fashion, and carry that money into retirement, at which point you’ll enjoy tax-free withdrawals as long as that money is used for qualified medical expenses. And since HSAs don’t impose RMDs, you’ll have the option to keep that money tucked away generating tax-free growth as you please.
RMDs aren’t always a problem for seniors; some retirees need to take those withdrawals anyway to cover their living expenses. But if you’d rather not be forced into taking RMDs, you can employ these strategies to defer or avoid them completely.