How RMDs Work and 7 Strategies to Reduce Their Tax Impact

A client recently sat in my office with a worried expression, saying she felt like she’d spent decades building her retirement accounts only to face a “tax time bomb” at age 73. “I’ve saved all this money in my 401(k),” she said, “but now I’m hearing the government is going to force me to take it out and pay huge taxes on it.”

Her concern about Required Minimum Distributions (RMDs) is one I hear often. 

After working with pre-retirees and retirees for years, I’ve learned that understanding RMDs and having strategies to minimize their impact can make a dramatic difference in how much of your hard-earned money you actually keep.

What Are Required Minimum Distributions?

Let me break this down simply. RMDs are mandatory withdrawals you must take from your tax-deferred retirement accounts like a 401k or IRA. For most people this starts around age 73. Think of it this way: when you contributed to your traditional IRA or 401(k), you got a tax break. The IRS essentially said, “We’ll let you skip taxes now, but we want our share eventually.” RMDs are how they collect.

These rules apply to traditional IRAs, 401(k)s, 403(b)s, SEP IRAs, and SIMPLE IRAs. Here’s the good news I always share with clients: Roth IRAs don’t have RMDs during your lifetime. That’s one of the reasons I’m such a big fan of Roth accounts for retirement planning.

When you reach RMD age, you pay ordinary income tax on withdrawals — not the lower capital gains rates many people expect. I’ve seen too many people get surprised by this, thinking their retirement account withdrawals would be taxed more favorably.

Miss an RMD and you’ll face a penalty that’ll make your head spin — 25% of what you should have withdrawn. I’ve helped clients who made this mistake, and it’s painful to watch. The good news? It’s completely avoidable with a little planning.

How RMDs Are Calculated

The calculation is actually pretty straightforward. You take your account balance from December 31st of the previous year and divide it by a life expectancy factor the IRS provides.

Here’s an example I use with clients: Say you turn 73 this year and your traditional IRA was worth $1 million at the end of last year. The IRS gives you a life expectancy factor of 26.5. Divide $1 million by 26.5, and your RMD for the year is about $37,736.

You’ve got until December 31st to take this withdrawal, except in your first RMD year when they give you until April 1st of the following year. But here’s what I tell clients about that extension: don’t take it unless you absolutely have to. Delaying means you’ll take two RMDs the next year, which can push you into a much higher tax bracket.

Why RMDs Can Create a Tax Headache

I’ve watched RMDs catch people off guard because they create what I call a domino effect with taxes. These withdrawals count as ordinary income, which means they can push you into higher tax brackets, increase how much of your Social Security gets taxed, and trigger higher Medicare premiums.

I had one client whose RMDs pushed her into a situation where she was paying thousands more in Medicare premiums — money she didn’t expect to spend. This combination often creates what we call a “tax torpedo,” and it can be devastating if you’re not prepared.

Seven Strategies I Use to Help Clients Reduce RMD Impact

Roth Conversions

This is one of my favorite strategies, but timing is everything. The best approach is converting portions of your traditional IRA to a Roth IRA before you reach RMD age. You pay taxes on the converted amount now — potentially while you’re in a lower bracket — and reduce the size of your future RMDs.

I often recommend this strategy for clients in their early retirement years when their income might be lower. The result? Smaller RMDs later and tax-free withdrawals from the Roth.

Qualified Charitable Distributions

If you’re 70½ or older and already giving to charity, this strategy is a game-changer. You can donate up to $100,000 annually directly from your IRA to qualified charities. The donation counts toward your RMD but doesn’t count as taxable income.

I’ve helped clients save thousands using this approach. One couple was giving $15,000 annually to their church anyway. By using a QCD instead of writing a check, they essentially made their charitable giving tax-free.

Delay Social Security

This strategy requires some finesse, but it can be powerful. By delaying Social Security and instead withdrawing from your IRA earlier in retirement, you can reduce the RMD burden down the line. I’ve seen this help clients level out their taxable income over time rather than getting hit all at once in their seventies.

Work With a Tax-Savvy Advisor

I’m biased here, but the timing of withdrawals and Roth conversions can make a huge difference over your lifetime. An advisor who understands the tax side of retirement planning can help you develop a strategy that keeps your lifetime tax bill as low as possible.

Take Early Withdrawals After Age 59½

If you retire before RMD age and find yourself in a relatively low tax bracket, it often makes sense to start drawing down your IRA early. This reduces the balance before RMDs kick in and spreads the taxes over more years.

I worked with a client who retired at 62 and was in a lower tax bracket for several years. By taking strategic early withdrawals, we significantly reduced his future RMD burden.

Consolidate Your Accounts

Having multiple IRAs or old 401(k)s scattered around makes tracking RMDs much harder. I always recommend consolidating these into one IRA when possible. It simplifies everything and reduces the chance of missing an RMD.

Just remember — and this trips people up — RMDs from 401(k)s and IRAs must be calculated separately if you have both types of accounts.

Reinvest RMDs Wisely

If you don’t need the RMD money for living expenses, don’t let it sit in cash. Just because you have to withdraw it doesn’t mean it can’t keep working for you in a taxable investment account.

The Bottom Line

Here’s what I tell every client: RMDs aren’t optional, but their tax impact is something you can control with the right planning. Whether you’re already retired or just a few years away, understanding how RMDs work and having strategies to minimize their bite can make a significant difference in your retirement plan’s success.

Don’t wait until the IRS forces your hand. I’ve seen too many people miss opportunities because they didn’t start planning early enough. A little proactive strategy today can save you thousands in taxes tomorrow.

Take the Next Step

Ready to develop an RMD strategy that keeps more money in your pocket? I can help you evaluate your current accounts, identify tax-saving opportunities, and create a plan that works for your specific situation.

To take the first step in aligning your money and your meaning and having the retirement you’ve always dreamed about, click to schedule a free consultation on our website.