If a person has already reached 70.5 years of age, the first thing to do is make sure he takes the RMD, otherwise the IRS will impose a 50 percent penalty on the amount that should have been withdrawn, says Adam Koos, president and portfolio manager at Libertas Wealth Management Group in Dublin, Ohio.
The first withdrawal can be delayed until April 15 of the year after a person reaches 70.5, but then a second RMD will need to be taken before December 31 of that same year. Taking two RMDs in one year may push the person into a high tax bracket.
Koos also advocates converting tax-deferred accounts into Roth accounts and paying the taxes. Any 401(k) money that is to be converted has to be changed to a traditional IRA first and then to a Roth IRA, he notes.
The goal for some retirees who do not need their required minimum distributions may be to leave the money to their children. Roth IRAs are good for this, says Rachele Bouchand, director of financial planning at Clark Nuber in Seattle. Traditional IRAs used as an inheritance tool are subject to both income tax and estate taxes, she points out. If the funds have been converted earlier, at least the heirs will not have to pay the income tax.
Bouchand asks, “Do the account holders expect any increases to their income? If so, it may make sense to have larger distributions while they are in a lower tax bracket. They can reinvest the proceeds in a taxable account, pay down debt or start education funds for grandchildren.”
You can also use the required minimum distributions (after you pay income tax on them) to buy a life insurance policy for yourself, your spouse or your children and grandchildren, or to buy hybrid life insurance or an annuity along with a long-term-care policy, notes Larry Rosenthal, an advisor with Voya Financial Advisors in northern Virginia. Also look at other accounts and make sure they are as tax efficient as possible, Rosenthal says.