As you approach retirement, you may focus on managing your savings effectively to ensure you don’t outlive your assets and income. However, one often-overlooked element that has the potential to impact your plans significantly is Required Minimum Distributions (RMDs).

These mandatory withdrawals from tax-deferred retirement accounts, such as 401(k)s and traditional IRAs, can create unexpected tax burdens. 

At 1st Choice Financial Services, Inc., headquartered in Camp Hill, PA, we help clients across Central Pennsylvania—Harrisburg, Hershey, Lancaster, and beyond—create and execute retirement plans that consider the financial and tax implications that RMDs could have on their retirements. 

Understanding RMDs and how they fit into your financial strategy is crucial; this blog will address this. Let’s dive right in.

Understanding RMDs

Imagine your tax-deferred retirement accounts (401(k), traditional IRAs, etc.) are like a large dam built to store water (in this case, your savings). Over the years, you’ve collected a significant amount of water behind your dam, representing all your savings for retirement.

• Building the Dam: Just like you’ve saved money in your retirement account, the dam has been filling with water for decades. The water level represents the balance in your account.

• The Spillway: The IRS, similar to a dam’s regulatory authority, mandates that once you reach a certain age (currently 73 for most), you must start letting water out of the dam. Just as a dam has a spillway to prevent overfilling and maintain safety, RMDs ensure that the wealth doesn’t just sit indefinitely in tax-advantaged accounts but starts flowing out, in this case, taxed to the owner.

• Managing the Flow: Each year, just like a dam manager calculates how much water to release based on various factors like current storage, expected rainfall, and downstream needs, you calculate your RMD. You figure out the amount based on your account balance and life expectancy tables provided by the IRS. This ensures you’re “releasing” just enough water (money) each year to comply with the law without draining your resources too soon or fast.

• Risks of Ignoring the Flow: If you fail to take your RMD, akin to not opening the spillway gates, you could face significant penalties. For a dam, this might lead to excess pressure or flooding; financially, you face a hefty tax as a penalty for not withdrawing the minimum amount required.

In 2025, if you miss taking your required minimum distribution (RMD), you’ll face a penalty of 25% on the amount you didn’t withdraw. However, if you correct this within two years, the penalty drops to 10%.

• Strategic Management: Just like a dam operator might choose when to release water for irrigation, power generation, or to prevent overflow, you strategically decide how to use your RMDs. You might reinvest it, use it for living expenses, or donate it to charity to reduce your taxable income.

2025 RMD Requirements

Here are the 2025 RMD withdrawal requirements:

• Starting Age:
  • If you were born in 1959 or earlier, RMDs start at age 73
  • If you were born in 1960 or later, RMDs begin at age 75

• Account Types Requiring RMDs:
  • Traditional IRAs
  • 401(k), 403(b), and 457 plans (excluding Roth versions)
  • SEP IRAs and SIMPLE IRAs

• Calculation:
  • RMD amounts are based on your account balance as of December 31 of the previous year and the IRS’s Uniform Lifetime Table
  • As noted earlier, failing to take your RMD on time can result in steep penalties—up to 25%. 

Watch our video on retirement planning strategies.

Why Are RMDs Taxable as Ordinary Income?

Because your contributions to tax-deferred retirement accounts were made with pre-tax dollars, your taxable income was reduced at the time of the contributions. 

As you prepare to withdraw from these accounts, the money in them must now be taxed. The earnings have been untaxed, and the investments have grown and compounded for several years. 

This is the difference between tax-deferred and tax-free.

RMDs are the withdrawal of previously tax-deferred money, now taxed as ordinary income since it was not taxed in the past. Your withdrawals are subject to ordinary income tax rates (10%-37%), unlike potentially lower capital gains tax in taxable accounts.

The Hidden Tax Impact of RMDs

When developing your retirement plan, be sure to work with a retirement planner in Central Pennsylvania who can help you develop a comprehensive RMD withdrawal strategy to limit your tax liabilities. 

Points to consider in your retirement and withdrawal strategy should include: 

1. Accounting for Higher Income Taxes: Because RMDs are added to your taxable income, this could push you into a higher tax bracket. This additional taxable income could create an unexpected financial strain if you have other income sources, such as Social Security.
   
2. Increased Medicare Premiums: Medicare premiums for Part B and Part D are determined by your Modified Adjusted Gross Income (MAGI). Large RMDs can push your MAGI over income thresholds, causing your premiums to increase.
   
3. Taxation of Social Security Benefits: If your combined income (including RMDs) exceeds a certain threshold, up to 85% of your Social Security benefits may become taxable.
   
4. Reduced Flexibility: Unlike other withdrawals, you can’t choose whether to take RMDs—they are mandatory. This rigidity can disrupt your financial plans, forcing you to withdraw and pay taxes on funds you don’t need.

Get to know the 1st Choice Financial Services team.

Strategies to Minimize the Tax Burden of RMDs

While RMDs are unavoidable for most retirees, strategic planning can help reduce their tax impact. Following are several productive  strategies:

1. Roth Conversions:
   
   Converting some of your traditional IRA or 401(k) funds into a Roth IRA before RMDs begin can help lower future RMD amounts. Roth IRAs are not subject to RMDs, and qualified withdrawals are tax-free.
   
   As retirement planning specialists in Central Pennsylvania, we can help you evaluate whether a Roth conversion is right based on your current tax situation.
   
2. Withdraw Strategically Before RMD Age:

If you’re in a lower tax bracket in the early retirement years, consider withdrawing from tax-deferred accounts before RMDs begin. This can reduce the size of your accounts and, therefore, your future RMDs.

3. Qualified Charitable Distributions (QCDs):
   
   If you’re charitably inclined, a QCD allows you to donate up to $100,000 annually from your IRA directly to a qualified charity. This amount counts toward your RMD but is excluded from your taxable income, providing a win-win solution.

4. Consolidate Retirement Accounts:
   
   Managing multiple retirement accounts can complicate RMDs. Consolidating accounts into a single IRA simplifies the process, making tracking and planning withdrawals much easier.

5. Use RMDs to Cover Living Expenses:
   
   If you’re already withdrawing funds to cover living expenses, align those withdrawals with your RMD requirements. This avoids additional distributions and tax impacts.
   
6. Invest RMD Proceeds Wisely:
   
   If you don’t need RMDs for immediate expenses, consider reinvesting them into a taxable brokerage account. While you’ll pay taxes on the distributions, the funds can continue to grow in a tax-efficient environment.

Why Choose 1st Choice Financial Services?

We hope this article helps illuminate how important it is for your retirement plan to consider the impact of Required Minimum Distributions (RMDs) to avoid unnecessary taxes and penalties. 

As experienced retirement advisors in Central Pennsylvania, we proudly serve clients in Camp Hill and the surrounding areas, including Harrisburg, Hershey, Halifax, Lancaster, and Lebanon, with comprehensive retirement planning services. 

We are grounded in a biblical foundation at 1st Choice Financial Services, Inc.. We believe that God asks us all to be good stewards of our finances. We are committed to helping you pursue the financial success God envisions for you and your family.

As an independent practice specializing in retirement planning, our mission is to help you maintain your quality of life and financial stability throughout your golden years. 

Being independent means we can tailor the best strategies to meet your unique retirement goals, free from the constraints of cookie-cutter portfolios. Plus, we are not affiliated with any brokerage firm, bank, or insurance company, so we can recommend solutions that genuinely serve the best interests of you and your family. 

Our commitment to you is captured in our dedication to the fiduciary standard. This means we pledge a duty of loyalty and care in all our actions, ensuring that your financial well-being is always our top priority.

Connect with us to learn more about our retirement planning services. 

Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.

The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, 1st Choice Financial Services, Inc., and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security, or any security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Foundations deems reliable any statistical data or information obtained from or prepared by third party sources that is included in any commentary, but in no way guarantees its accuracy or completeness.

A Roth conversion may not be suitable for your situation. The primary goal in converting retirement assets into a Roth IRA is to reduce the future tax liability on the distributions you take in retirement, or on the distributions of your beneficiaries. The information provided is to help you determine whether or not a Roth IRA conversion may be appropriate for your particular circumstances. Please review your retirement savings, tax, and legacy planning strategies with your legal/tax advisor to be sure a Roth IRA conversion fits into your planning strategies.