Strategies to Reduce RMD Tax: Keep More of Your Retirement Savings

For 35 years, Walter and Carol did everything the financial advisors told them. They maxed out their 401(k)s. They caught up on contributions after 50. They watched their balance grow from $100,000 to $500,000 to $1.2 million to nearly $2 million by the time Walter turned 73.

Then the first RMD notice arrived: $75,000.

Walter didn't need $75,000. His Social Security and pension covered their expenses comfortably. But the IRS didn't care what he needed. He had to withdraw at least $75,000 from his Traditional IRA, whether he wanted the money or not.

That $75,000 pushed them into the 22% bracket. Combined with Social Security, it pushed 85% of their benefits into taxable territory. It triggered Medicare IRMAA surcharges of $3,400 per year. And because his accounts kept growing even while withdrawing, next year's RMD would be even larger.

"We spent 35 years trying to avoid taxes," Carol said. "Now we're paying more in taxes than we ever did while working."

Walter and Carol's situation isn't unusual. It's what happens when tax-deferred savings work exactly as designed — and then the bill comes due. But it didn't have to be this way. With different planning in their 60s, they could have dramatically reduced the tax impact of their RMDs.

Why RMDs create tax problems

The mechanics work against you in compounding ways.

Each year, the IRS requires you to withdraw a percentage of your account balance based on your age. At 73, that percentage is about 3.8%. By 80, it's roughly 5%. By 90, it exceeds 8%. The percentage grows because you're expected to deplete the account over your remaining lifetime.

But here's the problem: if your account keeps growing despite the withdrawals — which often happens in strong markets — your required distribution grows in dollar terms even as the percentage rises. Walter's $2 million balance required $75,000 at age 73. If markets cooperate, his balance might still be $1.8 million at 80, requiring a $90,000 withdrawal. By 85, despite years of forced distributions, he might still be withdrawing $100,000+ annually.

Each dollar of RMD creates ripple effects beyond income tax. More Social Security becomes taxable — the "combined income" calculation includes RMDs, pushing more of your benefits into the 85% taxable zone. Medicare IRMAA surcharges kick in once MAGI exceeds $103,000 for singles or $206,000 for couples. And you lose various tax benefits that phase out at higher income levels.

The tragic irony is that Walter and Carol had a decade of low-income years between retirement at 63 and RMDs at 73. During those years, they were barely in the 12% bracket. They could have withdrawn or converted hundreds of thousands of dollars at low rates. Instead, they left the money alone to "grow" — and now they're paying 22% plus IRMAA plus maximized Social Security taxation.

The single most powerful strategy: Roth conversions before RMDs

If you do nothing else, understand this: the years between retirement and age 73 are golden for Roth conversions. You'll likely never have lower tax rates than during this window.

The strategy is straightforward. Convert money from your Traditional IRA to a Roth IRA. Pay taxes on the converted amount at today's rates. The converted money leaves the account that will generate RMDs and enters an account that has no RMDs whatsoever. Future growth is tax-free. Future withdrawals are tax-free. And when you die, your heirs inherit tax-free Roth money instead of heavily-taxed Traditional IRA money.

Consider what Walter and Carol could have done. At 65, their Traditional IRAs totaled $1.2 million. Their only income was $40,000 from Social Security and a small pension. They were solidly in the 12% bracket with room to spare.

If they'd converted $50,000 per year from age 65 to 72 — eight years at $400,000 total — they'd have paid approximately $48,000 in federal taxes over those years. But their Traditional IRA balance at 73 would have been roughly $1.1 million instead of $2 million (accounting for both the conversions and reduced growth on a smaller base). Their first RMD: about $42,000 instead of $75,000. Their tax bracket: probably still 12%. Their IRMAA exposure: minimal or none.

The conversions they didn't do will cost them far more than $48,000 over their remaining years. And that $400,000 in Roth accounts? It continues growing tax-free, available whenever they need it, without affecting their taxable income at all.

Qualified Charitable Distributions: the charitably-inclined solution

If you donate to charity anyway, Qualified Charitable Distributions offer one of the most efficient RMD strategies available.

The mechanics are simple. After age 70½, you can direct up to $105,000 per year from your IRA directly to qualified charities. These donations count toward your RMD requirement but don't count as taxable income. The money goes from your IRA to the charity without ever passing through your hands or appearing on your tax return as income.

Compare this to the normal approach: take your RMD, pay taxes on it, then donate to charity from what's left. If you're in the 22% bracket and donate $10,000, you actually need to withdraw about $12,800 to end up with $10,000 after taxes.

With a QCD, you donate $10,000 and that's exactly what it costs you. The charity receives the same amount. But you never recognize that income, so you don't pay the $2,800 in taxes. Your AGI is $10,000 lower. Your Social Security taxation is potentially reduced. Your IRMAA calculation improves.

The benefit is especially valuable for people who take the standard deduction. Normally, you get no tax benefit from charitable donations unless you itemize. QCDs provide a tax benefit regardless of whether you itemize, because the income simply never appears.

Walter and Carol give about $20,000 annually to their church and various charities. If they used QCDs, their taxable income would drop by $20,000. That's $4,400 in tax savings at the 22% bracket, plus potentially lower IRMAA surcharges, plus less Social Security taxation. Same charitable giving, dramatically better tax result.

The strategic timing of your first RMD

Your first RMD offers a unique planning opportunity that subsequent years don't.

The rule says you must take your first RMD by April 1 of the year following the year you turn 73. But you can also take it anytime during that first year if you prefer. This creates a choice: take one RMD in year one, or delay to April 1 of year two and take two RMDs in the same calendar year.

Taking two RMDs in one year sounds bad — and often is. It doubles your taxable income from required distributions, potentially pushing you into higher brackets, triggering IRMAA, maximizing Social Security taxation.

But sometimes it makes sense. If year one has unusually high income from other sources (maybe you're still working, or you sold a property), that year's taxes are already elevated. Adding an RMD doesn't hurt as much. Meanwhile, year two might have lower income, making the delayed first RMD plus regular second RMD less damaging than spreading across two higher-income years.

The decision requires projecting income for both years and modeling the tax consequences of each approach. For most people, taking the first RMD in the first year makes sense — spread the income, stay in lower brackets. But exceptions exist, and the wrong choice can cost thousands.

The still-working exception

If you're still employed at age 73 and participating in your current employer's 401(k), you can delay RMDs from that plan until you actually retire. This exception applies only to your current employer's plan — not old 401(k)s from previous jobs, and not IRAs.

The strategic implication: if you plan to work past 73, consider rolling your old 401(k)s and IRAs into your current employer's 401(k) before the RMD start date. This consolidates everything into the account that qualifies for the still-working exception, potentially delaying all your RMDs until you actually stop working.

There are catches. You can't own more than 5% of the company. Your current plan must accept rollover contributions. And the plan's investment options might be worse than what you'd have in an IRA. But for the right situation — someone planning to work until 75 or later with significant Traditional account balances — this strategy can defer RMDs for years beyond the normal deadline.

The QLAC option for longevity insurance

A Qualified Longevity Annuity Contract lets you use a portion of your retirement funds to purchase guaranteed income that starts at an advanced age — up to 85.

The portion invested in a QLAC (up to $200,000 or 25% of your account, whichever is less) is excluded from RMD calculations. If you have a $1 million IRA and put $200,000 into a QLAC, your RMDs are calculated on $800,000 instead. That's a 20% reduction in required distributions for as long as you live.

When the QLAC payments begin (you choose the starting age up to 85), they're taxable income. But you've gained years of reduced RMDs, and the payments provide longevity insurance — guaranteed income no matter how long you live.

The trade-off is liquidity. Money in a QLAC is locked up. You can't access it early if you need it. And the returns might be lower than what you'd earn invested in the market. But for someone worried about outliving their money and wanting to reduce RMDs, QLACs offer a unique combination of benefits.

Coordinating with Social Security

The timing of Social Security affects RMD taxation, and vice versa.

If you delay Social Security until 70, you have more years of low income before RMDs begin — prime conversion territory. Then, when both Social Security and RMDs start, you're dealing with lower Traditional IRA balances (because you converted) and higher Social Security benefits (because you delayed). The higher Social Security replaces some income you might otherwise withdraw from accounts, and the smaller Traditional balance means smaller forced distributions.

Conversely, claiming Social Security early adds income during the years when you might otherwise convert at low rates. The extra Social Security income pushes you higher in the brackets, making conversions more expensive.

The interaction works both directions. Large RMDs increase your AGI, which affects how much of your Social Security becomes taxable. If your RMDs are small (because you converted), less of your Social Security is taxed. If your RMDs are large (because you didn't convert), more of your Social Security is taxed.

The planning takeaway: Social Security timing and RMD management should be coordinated, not treated as separate decisions.

The bottom line on RMD reduction

Walter and Carol can't undo their decisions from the past decade. But they can act now to limit future damage.

They've started using QCDs for their charitable giving — $20,000 per year that no longer adds to taxable income. They're exploring whether a QLAC makes sense for a portion of their balance. And they're resigned to paying more than they should have, knowing that the window for optimal planning has largely closed.

But if you're reading this in your 50s or 60s — before RMDs begin — you have the opportunity Walter and Carol missed. The time to reduce RMD taxation is five to ten years before RMDs start. Every year you delay action is a year of low-bracket conversion opportunity wasted.

The strategies work. The math is clear. The only question is whether you'll act in time.

Want a personalized RMD tax reduction strategy? Connect with a retirement advisor who can analyze your specific situation and create an optimized plan.