I'm 59 1/2, Will I be Penalized on Early IRA Withdrawals? | Strategic RMD and Tax Planning

Exploring Retirement Income Strategies

Casey: Wendy has a great question about IRAs and RMDs saying, "I just turned fifty-nine-and-a-half, and I'm looking at making moves with my IRAs ahead of any huge required minimum distributions later. If I take out an amount that keeps me just below a tax rate increase this season, will the IRS hit me with penalties and/or interest on that money, or will I just have to pay the taxes alone on the distribution?"

Marshal: Wow. What a thoughtful question from Wendy. That might actually be the most beneficial question to listeners that we've gotten in a long time, because she raises an interesting point. One, she recognizes, Case, that her RMDs are going to be large someday, right? I think a lot of people dismiss that when they look at what their RMDs are, the required minimum distributions are going to be at 72 or 73. They look at it and go, "It's not that bad."

Guess what? The dollars keep compounding, the dollars keep growing, and also the required minimum distribution amount keeps going up as we age. She's absolutely right. if you had a million bucks at age 61 at, say, a 6% rate of return, that thing is going to double in 12 years. That million dollars turns into $2 million by the time she's required to take her required minimum distributions. Her required minimum distributions divide by 26.5. She's got $75,000, Casey, that's coming out at the start of retirement.

What she's trying to do is get ahead of that and start to pay some of these taxes, but she is correct, either withhold taxes from the distribution or speak with your accountant and try to set up some quarterlies to make sure that the IRS gets paid in a timely manner.

Casey: I want to point out something as well, that the RMD, if you're fifty-nine-and-a-half today, you might be thinking about this age 73, but because of the Secure Act 2.0 legislation that was passed by Congress in December of 2022, your actual RMD age is going to be beyond that. By the time we get to 2033, which, well, Wendy is going to be-- She's, what? 13 years away from her RMD age typically. It's actually age 75 because the age was increased from 70 to 72 to 73. It'll be 75 by the time we get to 2033.

You have a huge opportunity, Wendy. You're in this beautiful window that I talked about on the YouTube channel in a short not long ago where you're finding yourself in control of your IRA for the first time in history. What you're probably thinking about in penalties, you're saying, "Well, prior to fifty-nine-and-a-half, if I took money out of my IRA, I had to pay a 10% penalty tax on that," which is true. Now, that doesn't apply to conversions. You could have been doing conversions if you're 50, 45, 52, 32. You can do a conversion and not have to concern yourself with paying that 10% penalty tax.

Marshal: As long as you pay the taxes on the conversion out of your pocket.

Casey: Yes. Now, if you are paying it out of the conversion, you may have to pay penalties. Now you're after fifty-nine-and-a-half, so you can do this conversion and you can actually pay that conversion. You can pay for the conversion out of your IRA. You can do some tax withholding on the conversion itself. You're in this window of control. Prior to fifty-nine-and-a-half, you had to pay 10% penalty taxes. Now, after 75, the IRS is going to come in and say, "Hey, you need to take this money out." You're going to be limited because when you have a required minimum distribution, you can't convert that RMD to a Roth IRA.

Marshal: Right.

Casey: Right now, Wendy, you have 15 years, 15 years to get control of that and systematically do these Roth conversions and do it very strategically, which is what it looks like you're trying to accomplish because you're talking about your tax brackets and filling up your existing tax bracket ahead of what an RMD could be probably going to be substantially more than $75,000 down the road in the example that Marshal just gave.

This is how you can end up paying more in taxes in retirement than you did during your working years because you did such a good job saving in your 401k. Now you're going to be forced to take these really big distributions combined with your Social Security taxes, combined with maybe pension income, combined with Medicare premium penalties. All of these things wrapped into one might mean you're effectively paying an even higher rate of taxes in retirement than you were during your working life, so you have to project those things forward.

I was just sitting down with a couple here not long ago, and we were looking at what that projection was going to be. When we projected that thing forward, we quickly saw how they had a six-figure income in retirement, and they never thought that was going to be possible. It was going to be completely out of their control until we put a strategy in place that put them back in the driver's seat.

Marshal: I sat down with a family last week, Casey, and we looked at it. They said, "Well, how much should we convert?" We started looking at where their tax rates are today. Because they're both retired, their tax rate's like zero, 10%. They're in the first tax tier. I said, "Well, what was your combined income when you were both working?" They had modest jobs. They were making $130,000, $140,000. We fast-forward, look out at a 3%, 4%, like a conservative rate of return, and these individuals were going to have higher income in their 80s than they ever did in their 50s. Getting ahead of this is quite a good thing that Wendy's thinking about, trying to help herself down the road, and I think she's on the right track.