In the course of deciding whether to save for retirement in a traditional account versus a Roth, people tend to focus on when they’re getting a tax break. With a traditional IRA or 401(k), you get a tax break on your contributions. With a Roth IRA or 401(k), you get a tax break on your withdrawals.
But there’s another key factor to consider when you’re deciding between a traditional or Roth retirement plan. Traditional IRAs and 401(k)s force savers to take required minimum distributions, or RMDs, whereas Roth accounts do not. And those RMDs could introduce some complications during retirement, since they can create an unwanted tax headache.
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If you have a traditional retirement plan that’s subject to RMDs, it’s important to understand the rules involved. And it’s also important to time your RMDs carefully.
RMDs begin at age 73 (or 75 for younger workers) and are due by Dec. 31 each year. Failing to meet that deadline could subject you to a 25% penalty.
Technically, this means you could take your RMD on the last day of the year and be just fine in terms of avoiding penalties. But that doesn’t mean waiting until the last minute to take your withdrawal is a smart decision.
Remember, any money you withdraw in RMD form is taxable income. If you wait until the very end of the year to take an RMD, you may lose out on opportunities to plan strategically.
Let’s say you take your RMD at the very end of December and find out that your additional income pushes you into a higher tax bracket. At that point, you may not be able to do much to offset that.
But let’s say you take your RMD earlier in the year and realize you’re likely looking at a significant increase in your tax rate. You may, at that point, have time to take steps to compensate, like selling assets at a loss or doing other things to reduce your taxable income overall.
Another issue with taking your RMD late in the year? Potential market volatility.
If you’re forced to sell assets when their value has fallen to meet the RMD deadline, you risk a longer-term portfolio decline that could be tricky to recover from. If you plan for your withdrawals earlier or take them at different intervals during the year, you can potentially reduce the risk of being forced to sell when the market is at its worst.
