Lowering Taxes on RMDs and Avoiding Common Pitfalls

Lowering Taxes on RMDs and Avoiding Common Pitfalls

By Joe Dowdall, CFP®, RICP®, CRPC®, CCFC 

Many retirees are surprised to discover how required minimum distributions (RMDs) can trigger unexpected taxes during retirement. While the goal of RMDs is to verify that you eventually pay taxes on your deferred savings, taxes on RMDs can significantly impact your golden years. 

As a fee-only fiduciary financial advisor, my role is to help clients optimize their income and reduce taxes. When you approach or transition into retirement, I focus on helping you manage your savings to support you throughout your retirement years.

Today, I want to share my insight on common RMD pitfalls and how to avoid them with tax-efficient retirement planning. 

What Are RMDs and Why Do They Matter?

RMDs are mandatory withdrawals from certain retirement accounts (like traditional IRAs and 401(k)s) starting at age 73 or 75, depending on your birth year. The calculation for your RMD amount is based on your account balance at the end of the previous year and your life expectancy as determined by IRS RMD calculations.

Failing to take your RMDs on time can lead to significant financial repercussions. The IRS levies a steep penalty of 25% (and potentially even 10% if corrected quickly) on the amount you failed to withdraw. 

However, simply taking your RMDs without a proactive strategy can also have costly side effects like bumping you into a higher tax bracket. The higher taxable income can trigger increased Medicare Part B and Part D premiums through Income-Related Monthly Adjustment Amounts (IRMAA).

Therefore, strategically managing your RMDs is paramount to maximizing your retirement income and avoiding unnecessary tax liabilities.

Common Tax Pitfalls of RMDs

Now let’s take a look at some scenarios that illustrate common RMD tax pitfalls.

The “Social Security Tax Torpedo”

Imagine Bill, a recent retiree, who wanted to take an extra $1,000 from his IRA to see his favorite artist in Austin. Bill anticipated paying $220 in taxes on the withdrawal (at a 22% bracket). 

Instead, he owed $407 (over 40%) because the added income made more of his Social Security benefits taxable.

The takeaway from Bill’s situation is that even a small RMD or extra withdrawal can create a domino effect, increasing the taxation of Social Security benefits and pushing your effective tax rate much larger than anticipated.​​

Medicare Surcharges (IRMAA)

Consider George and Martha, both on Medicare, who sold an investment that resulted in a $1,000 gain. They understood they’d owe 18.8% in capital gains tax ($188). 

However, the additional income nudged their Modified Adjusted Gross Income (MAGI) just over a threshold, triggering IRMAA surcharges. 

The result was that George and Martha’s Medicare Part B and D premiums increased by over $3,000 for the year. In total, that $1,000 gain cost them $3,195 in taxes and surcharges—a 319.5% effective tax rate!

The lesson to learn here is that even a modest RMD or capital gain can push you over IRMAA thresholds, leading to steep and unexpected increases in Medicare premiums.​

Strategies for Avoiding RMD Tax Pitfalls

While RMDs are unavoidable, proactive planning and strategic execution can significantly reduce their tax impact and help you retain more of your hard-earned retirement savings. 

Consider these strategies:

Start Planning Early

  • Calculate your anticipated RMDs before reaching the age threshold.
  • Understand how your distributions affect your total income and taxes.

Roth Conversions

  • Definition: A Roth conversion involves transferring funds from a traditional, pre-tax retirement account (like a traditional IRA or 401(k)) into a Roth IRA, requiring you to pay taxes on the converted amount in the year of the conversion, but allowing future qualified withdrawals from the Roth account to be tax-free.
  • Why it matters: When properly structured, Roth conversions provide tax-free withdrawals in retirement from Roth accounts, thereby lowering the amount subject to RMDs in the future.
  • Example: Let’s say you retire at age 65 but delay Social Security until age 70. You have five years of potentially low income, making it a great window to convert some traditional IRA assets to a Roth IRA, paying taxes now at a lower bracket and avoiding RMDs on those converted funds later.

Qualified Charitable Distributions (QCDs)

  • Definition: A qualified charitable distribution (QCD) is a tax-efficient strategy allowing individuals aged 70½ or older to directly transfer up to $108,000 (for 2025) annually from their IRA to an eligible charity, which counts toward their required minimum distribution (RMD) but is excluded from their taxable income.
  • Why it matters: QCDs can be a powerful strategy for those who are charitably inclined and want to reduce both taxable income and RMDs.​
  • Example: Albert and Shirley gave $5,000 to charity from their IRA, thinking it would reduce their taxable income. Because they take the standard deduction, their charitable gift had no federal taxes, and the $5,000 counted as taxable income (costing them $1,200 in taxes). By instead making a QCD—having the IRA send the gift directly to the charity—the distribution counts toward their RMD but is excluded from taxable income, saving them $1,200 in taxes.

Monitor Your Income and Coordinate With Social Security

  • Definition: Stay alert to how RMDs interact with Social Security taxation and Medicare surcharges. Adjust as needed to avoid unnecessary surprises.
  • Why it matters: Conventional wisdom says you should spend your taxable money first, then tax-deferred money, then tax-exempt money. This isn’t necessarily a bad approach, but be sure to customize this bucket approach for your specific situation.
  • Example: Sam and Mary have multiple account types for retirement income. The conventional wisdom says to spend taxable money first, then tax-deferred (IRAs/401(k)s), then tax-exempt (Roth IRAs). However, by customizing their withdrawal strategy—using Roth conversions in low-income years—they can fill up lower tax brackets and increase their tax-free “bucket” for the future, reducing overall lifetime taxes.

Don’t Let Taxes Erode Your Savings 

With proactive planning, you can avoid the most common tax traps associated with RMDs and help your retirement savings last longer.

At Worth Asset Management, my priority is to build personalized relationships with my clients. I’m not just your financial advisor. I am a fiduciary and a trusted advocate here to help you through retirement. I understand these are not just numbers or an account balance; it’s your financial future.

Get started today with a 15-minute introductory call. I can be reached at (469) 423-1989 or by email at joe@worthassetmgmt.com. 

About Joe

Joe Dowdall is a CERTIFIED FINANCIAL PLANNER® professional at Worth Asset Management, a financial services company in Dallas, TX, that provides a wide range of wealth management services. With over 15 years in the financial services industry, Joe is a fiduciary who creates tax-focused financial plans for people nearing or in retirement—to help them build and safeguard their wealth through all life stages. He desires to offer clients the best financial planning experience while developing a friendship based on mutual respect. Joe’s philosophy as a financial planner is rooted in his experience as a teacher, where he learned the importance of explaining complicated concepts in understandable terms. He’s passionate about working with a select group of clients to help them achieve their financial goals with confidence and clarity.

Joe has an education degree from the State University of New York and an MBA in finance from Saint Joseph’s University. In addition, he has obtained the CERTIFIED FINANCIAL PLANNER®, Retirement Income Certified Professional®, Chartered Retirement Planning Counselor℠, and Certified College Financial Consultant (CCFC) designations. Joe resides in Frisco, TX, with his wife, Leila, and their two daughters. During his free time, he enjoys traveling with family, exercising, and hiking the national parks. To learn more about Joe, connect with him on LinkedIn.

The information provided is for general guidance and informational purposes only. Please consult with a qualified tax professional for advice tailored to your specific financial situation.