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Large balances can cause a ‘tax nightmare’
For some investors, bigger pretax accounts can be “a tax nightmare in retirement” when it’s time for RMDs, certified financial planner Derek Williams with Veratis Advisors in Cary, North Carolina previously told CNBC.
Pretax RMDs boost your adjusted gross income, which can cause higher Medicare Part B and Part D premiums, among other tax consequences, he said.
Your RMD is based on your pre-tax retirement balance as of Dec. 31 from the previous year. That means your 2024 RMD uses year-end figures from 2023.
For 2024, the calculation divides your 2023 pretax balance by an IRS life expectancy factor.
If you skip an RMD or don’t take the full amount by the deadline, you can expect a 25% excise tax on the amount not withdrawn. The penalty falls to 10% if the RMD is “timely corrected within two years,” according to the IRS.
The agency could waive the RMD penalty if the shortfall was due to “reasonable error” and you take “reasonable steps” to correct it. But you must file Form 5329 with a letter of explanation.
Reduce taxes with charitable transfer
If you need to take an RMD and also want to plan a year-end gift to charity, it’s possible to accomplish both with a qualified charitable distribution, or QCD, experts say.
QCDs are transfers from an individual retirement account to a non-profit organization, which “counts against your RMD but doesn’t get added to your taxable income,” according to CFP Michael Lofley with HBKS Wealth Advisors in Stuart, Florida.
Plus, you can use the strategy to score a tax break for charitable gifts, even if you don’t itemize deductions on your tax return, said Lofley, who is also a certified public accountant.
There’s been a higher standard deduction since 2018, and only about 10% of taxpayers itemized tax breaks on 2021 returns, according to the most recent IRS filing data.