Retirement Account Balances Soar to New Highs in 2023, but Pose a Dilemma for Retirees

As the stock market continues to surge, retirement account balances have reached unprecedented levels. However, for retirees who depend on these funds, this presents a mixed blessing.

A key factor is the requirement for older individuals to withdraw money from their traditional pretax 401(k) and individual retirement accounts each year. These mandatory withdrawals, known as required minimum distributions (RMDs), are calculated based on the account balance at the end of the year and the individual’s life expectancy.

Fidelity Investments, a prominent IRA administrator, predicts that clients’ cumulative RMDs will reach a record high of $25 billion in 2024. This is partly due to the soaring stock indexes such as the Dow Jones Industrial Average at the close of 2023.

The higher year-end balances in 2023 mean that retirees will need to withdraw more from their retirement accounts in 2024, consequently increasing their tax liabilities. Although tax brackets are adjusted for inflation, the strong market performance of 2023 may push some retirees into higher tax brackets. It may also subject them to surcharges on future Medicare premiums and a 3.8% surtax on net investment income for those exceeding certain income thresholds.

Additionally, Congress recently raised the age at which individuals must start withdrawing money from retirement accounts to 73, providing an opportunity for tax-deferred growth of investments for longer. However, when RMDs do begin, they tend to be larger due to the shorter life expectancy of older individuals.

To mitigate the impact of higher RMDs, tax, and financial advisers recommend the following strategies:

1. Qualified charitable distributions (QCDs): By donating the entire RMD directly to eligible charities, retirees can avoid taxes on these distributions. QCDs do not count as taxable income, ensuring that AGI remains unaffected, thereby reducing the impact on Medicare surcharges and other tax deductions.
2. Roth conversions: Converting a portion of traditional retirement account savings to a Roth account can help shrink the overall balance. Although income tax must be paid on these conversions, Roth accounts are exempt from RMDs.

Considering the scheduled expiration of certain tax cuts in 2025, retirees may also want to consider withdrawing more than the minimum required from their retirement accounts to take advantage of lower tax brackets. It is important for retirees to be aware of recent changes in RMD rules for inherited retirement accounts, as beneficiaries are now required to drain these accounts within a decade.

By employing these strategies and staying informed, retirees can navigate the complexities of RMDs and optimize their retirement finances.