Most of us would prefer not to pay up-front for anything that could be paid for at a later time. That is true for paying income taxes on retirement distributions, including distributions from the Thrift Savings Plan (TSP), from traditional IRAs, and from inherited traditional IRAs.
One of the provisions coming out of SECURE Act 2.0 (passed into law by Congress in December 2022) is that the required minimum distribution (RMD) age was raised to age 73 (from age 72 and age 70.5, the RMD ages in previous years). For many retirees and beneficiaries of retirement accounts, the increase in the RMD age was welcome news, but not for the right reasons. While most individuals, especially those who are retired and over age 65, embraced this change because it meant they could delay RMDs for a few more years, it was not the right way to look at the delay of RMDs.
Delaying retirement plan RMDs like from the TSP and traditional IRA RMDs only causes the tax problem associated with RMDs to worsen. This is because the longer the funds in a traditional retirement account remain in the account, the longer the account will grow – tax deferred. A better way to utilize this delay of RMDs is to make voluntary (unrequired) traditional TSP and traditional IRA distributions before one’s required beginning date (RBD) at which time RMDs start. This is especially the case during 2024 and 2025 when individual tax rates are low, a result of the passage of the Tax Cuts and Jobs Act of 2017 (TCJA). TCJA reduced individual tax rates to the lowest amount they have ever been. But TCJA reduced individual tax rates but only temporarily. Unless Congress reviews TCJA, the low individual rates will cease on December 31, 2025. Effective January 1, 2026, individual tax rates will revert back to the higher tax rates they were in 2017, inflation adjusted.
Another suggestion to utilize this delay of the RBD is to convert portions of one’s traditional IRAs to Roth IRAs, using the low rates in effect during 2024 and 2025. Converting portions of traditional IRAs to Roth IRAs, paying the income taxes due at discounted rates, will move some of the traditional IRAs to Roth IRAs and reduce future RMDs. Once the funds are moved from the traditional IRA and converted to Roth IRAs, the funds will grow income tax-free for life and 10 years beyond to beneficiaries. Roth IRAs are not subject to RMD.
An important fact to keep in mind is that when RMDs start at one’s RBD, the Roth advantage on traditional IRA funds is lost. This is because traditional IRA RMDs can never be converted to Roth IRAs.
In addition to taking unrequired distributions and performing Roth IRA conversions before reaching one’s RBD, another tax-saving strategy is making qualified charitable distributions (QCDs) starting at age 70.5. For those individuals who are accustomed to charitable giving, traditional IRA funds can be transferred to charitable organizations at a zero-tax cost before RMDs are due. This will lower traditional IRA balances and therefore future RMDs. Once RMDs are due, QCDs can also offset otherwise taxable RMD income. Note for QCD to offset a taxable RMD, an individual who has reached his or her RBD (and must therefore take a traditional IRA RMD every year) must perform a QCD during the year before taking a traditional IRA distribution in order to meet the traditional IRA RMD for that year. The following example illustrates:
Example 1*. Sally, age 75, owns a traditional IRA which was valued at $850,000 as of 12/31/2023. Her 2024 traditional IRA RMD is equal to $34,553 ($850,000/24.6). In January 2024, Sally made a QCD of $17,500 to her church. In February 2024, Sally made a $16,000 QCD to the Goodwill. Of the $34,553 IRA RMD, Sally fulfilled $17,500 plus $16,000, or $33,500 via two QCDs. Both QCDs are income tax-free. Sometime between now and December 31, 2024, Sally must request a 2024 traditional IRA distribution of $34,553 less $33,500 or $1,053. The $1,053 is fully taxable. While the $33,500 QCDs are not taxable income for 2024, Sally cannot claim a charitable contribution for the $33,500 on her Schedule A as part of her 2024 federal tax return.
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Delaying TSP RMDs
The Thrift Savings Plan (TSP) allows TSP participants who have reached their RBD to delay taking their TSP RMD if they are still in federal servcie. Their first TSP RMD is delayed until April 1st of the year after they retire from federal service.
However, the delay of taking TSP RMD does not apply to traditional IRAs and other qualified retirement plans that the TSP participant owns. However, traditional IRA distributions in excess of the traditional IRA RMD for that year can be converted to a Roth IRA. The following example illustrates:
Example 2*. Jose, age 74, is a federal employee with a traditional TSP account and a traditional IRA account worth $550,000 as of December 31, 2023. Jose is still in federal service during 2024 and therefore does not have to take a 2024 TSP RMD. However, Jose has to take a traditional IRA RMD during 2025 which is equal to:
$550,000/25.5 = $21,569
On July 1, 2024, Jose requests a $25,000 IRA distribution. Of the $25,000, $21,569 fulfills Jose’s 2024 traditional IRA RMD. The remaining $25,000 less $21,569, or $3,431, is eligible to be converted to a Roth IRA.
* This is a hypothetical example for illustration purpose only and does not represent an actual investment.
Traditional IRA Beneficiaries Subject to the 10-Year Rule
Most non-spousal traditional IRA beneficiaries are subject to the 10-year rule, meaning that they must withdraw the entire amount of their inherited traditional IRA within 10 years of the original traditional IRA owner’s death. They are advised to request voluntary contributions over the 10-year period. Periodic withdrawals during the 10-year period are recommended rather than waiting for the end of the 10th year to make a lump-sum withdrawal. Making a required lump sum withdrawal at the end of the 10th year could result in a huge federal and state tax liability.
The fact is that spreading distributions over the 10 years can “smooth out” the overall tax bill by taking advantage of lower tax brackets rather than getting the benefit of only one yar of those low tax brackets.
In April 2024, the IRS issued Notice 2024-35 waiving 2024 RMDs for beneficiaries who were originally subject to annual RMDs for years one through nine of the 10-year term. While this may sound like good news for traditional IRA beneficiaries, those beneficiaries who take advantage of this year’s waiver (in addition to the IRS waivers that happened during 2021, 2022 and 2023) will accumulate huge federal and state income tax bills. This is because more of these inherited traditional funds have to be withdrawn in a shorter period, resulting in a larger tax bill.
In summary, for many traditional IRA owners and traditional TSP participants who are current in their late 60’s and getting close to their RBDs, delaying RMDs sounds good now in 2024. The delay in inherited traditional IRA RMDs for non-spousal beneficiaries also sounds appealing. However, the future tax bill will continue to compound over time. Paying taxes on retirement plans and traditional IRA distributions during 2024 and 2025 will pay off in the future with big tax-free gains. This is especially true if income tax rates increase after December 31, 2025. The overall tax pain that comes with withdrawing traditional IRA and traditional TSP funds can be minimized by taking more distributions now during 2024 and 2025 when individual federal tax rates remain low. To put it in more succinct terms, “no pain (now), no gain(later).”
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Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert
A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement!
Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach
and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over
20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s
writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.
He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters,
and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about
their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
