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Level 4

Avoiding tax in RMD withdrawal

I have a large RMD withdrawal with a big tax hit.  Would it be of any benefit to exchange long held IRA funds for a tax free (fed and state) muni fund? 

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Level 20

Avoiding tax in RMD withdrawal

If you are asking about simply changing your investment within the IRA, no.  Gains in a traditional IRA are taxed as ordinary income on both the federal and state level.  The only way to avoid taxation on traditional IRA distributions is to make a Qualified Charitable Distribution where up to $100,000 per year is sent from your IRA by your IRA custodian directly to a qualified charity.  However, some states to not recognize QCDs as nontaxable.


Assuming that this is your own traditional IRA and not an inherited traditional IRA, to reduce future taxable growth on IRA investments, after making the IRA's RMD for the year you might consider converting some to a Roth IRA.  This will increase your tax liability since the Roth conversion is taxable, but, since you are over age 59½, subsequent growth in the Roth IRA will be tax free once the 5-year holding period determining qualified Roth IRA distributions is met.  The Roth conversion will reduce the amount in the traditional IRA subject to RMDs in future years.  You'll want to be careful as to how much you convert to Roth each year so that, generally, you are not paying tax in a higher tax bracket on the Roth conversion than you would if you just paid the tax on later RMD distributions from the traditional IRA.

4 Replies
Level 20

Avoiding tax in RMD withdrawal

If you are asking about simply changing your investment within the IRA, no.  Gains in a traditional IRA are taxed as ordinary income on both the federal and state level.  The only way to avoid taxation on traditional IRA distributions is to make a Qualified Charitable Distribution where up to $100,000 per year is sent from your IRA by your IRA custodian directly to a qualified charity.  However, some states to not recognize QCDs as nontaxable.


Assuming that this is your own traditional IRA and not an inherited traditional IRA, to reduce future taxable growth on IRA investments, after making the IRA's RMD for the year you might consider converting some to a Roth IRA.  This will increase your tax liability since the Roth conversion is taxable, but, since you are over age 59½, subsequent growth in the Roth IRA will be tax free once the 5-year holding period determining qualified Roth IRA distributions is met.  The Roth conversion will reduce the amount in the traditional IRA subject to RMDs in future years.  You'll want to be careful as to how much you convert to Roth each year so that, generally, you are not paying tax in a higher tax bracket on the Roth conversion than you would if you just paid the tax on later RMD distributions from the traditional IRA.

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Level 4

Avoiding tax in RMD withdrawal

Thank you for your ideas.
Level 18

Avoiding tax in RMD withdrawal

you may want to contact a financial advisor.   they will look at the taxes to be paid on conversion, your life expectancy and other matters.     Having prepared tax returns for a long time, once in a while a person who does a conversion does not live long enough to recover the additional taxes paid up front.   


munis really don't make sense in a taxable IRA , because any distribution (other than rollover) is  taxable.

 

Level 4

Avoiding tax in RMD withdrawal

I agree, I won't be converting to a Roth at this age.  No advantage now, and no children that might benefit from an inheritance.