Saving for retirement in a traditional IRA or 401(k) can make a lot of sense during your working years, especially if you're in a higher tax bracket. That's because your contributions get to go in tax-free, shielding some of your income from the IRS.
The problem with traditional retirement accounts is that eventually, you'll be forced to start taking required minimum distributions, or RMDs. And those could drive up your tax bill in retirement.
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That's not the only problem with RMDs, though. Depending on what they amount to, they could have a serious impact on your Social Security benefits and Medicare premiums.
How RMDs affect Social Security
Social Security benefits aren't automatically exempt from taxes. There are income limits that determine whether those benefits get taxed at the federal level or not. However, those income limits are specific, and they're based on what's called provisional (or combined) income.
Provisional income is calculated by taking your adjusted gross income (excluding Social Security) and adding in any tax-free income you receive plus 50% of your annual Social Security income. From there, the thresholds for taxes on Social Security benefits are pretty low:
- Single tax-filers with a provisional income between $25,000 and $34,000 face federal taxes on up to 50% of their Social Security benefits.
- Single tax-filers with a provisional income above $34,000 face federal taxes on up to 85% of their Social Security benefits.
- Joint tax-filers with a provisional income between $32,000 and $44,000 face federal taxes on up to 50% of their Social Security benefits.
- Joint tax-filers with a provisional income above $44,000 face federal taxes on up to 85% of their Social Security benefits.
Here's where RMDs come into play. If you have low expenses are able to get by on your Social Security benefits alone, you may end up below the threshold of having to pay taxes on those benefits. But if RMDs push your provisional income upward, your benefits could end up getting taxed.
Here's an example. Say you're single and your only retirement income is a $3,000 monthly Social Security check. Half of that, on an annual basis, is $18,000, which puts you below the threshold for having to pay taxes on your benefits.
But now let's say you're on the hook for a $10,000 RMD this year because you've turned 73. That gets added to the $18,000 above, pushing your provisional income to $28,000 and leaving you subject to taxes on up to 50% of your Social Security benefits.
How RMDs affect Medicare
Medicare has a standard Part B premium enrollees are charged. But higher earners can face surcharges on those premiums known as income-related monthly adjustment amounts, or IRMAAs.
IRMAAs are based on your modified adjusted gross income (MAGI) from two years prior. So this year, they're based on 2024 income. In 2026, IMRAA surcharges are added to your premiums if your 2024 MAGI was over $109,000, or $218,000 if you're married.
We don't know what the IRMAA thresholds will look like in 2028. But if you're subject to a large RMD this year, it could push your MAGI high enough to require you to pay more for Medicare two years down the line.
How to manage the impact of RMDs
Clearly, RMDs have consequences beyond just a higher tax bill. So it's important to do what you can to minimize the blow.
One strategy is to begin taking withdrawals from retirement accounts that are subject to RMDs once you're old enough to avoid early withdrawal penalties -- meaning, age 59 and 1/2 or later. If you have, say, a $1 million IRA, but you start tapping that account at age 60, by the time you turn 73, you may not have very large RMDs to worry about.
That said, you don't want to blow through your IRA simply to avoid RMDs. The above strategy works if, for example, you have other income saved you can use once you turn 73. It can also work if you withdraw from your IRA to reduce RMDs but reinvest the money or save it elsewhere.
Another strategy worth exploring is doing Roth conversions before you become eligible for RMDs. If you give yourself a long window to do those conversions, you can minimize the year-to-year tax consequences.
Remember, money you convert to a Roth account counts as taxable income for that year. So if you have a $1 million IRA, you don't want to do a conversion in a single year. But if you start doing conversions at age 60, you can spread them out over more than a decade, thereby leading to a moderate but not overwhelming tax bill each year.
RMDs could cause more financial harm than just larger tax bills in retirement. It's important to be aware of these consequences and take a proactive approach to minimizing the impact of RMDs, whether via strategic withdrawals or Roth conversions, before it's too late.
