Ways to reduce income tax when you began making IRA withdrawals?

Question

Any ideas to save on income tax before one has to start making withdrawals from IRA?
I thought one way would be if you're 67 years old and you know you will have major medical expenses in these next 2 years, should you withdraw some out of your IRA since you will be able to deduct the medical expenses from your taxes? Otherwise, if you wait till 70 1/2, then you will not have the deduction benefit.
Any other ways to save income tax when you start making IRA withdrawals?

great answers so far.
The medical expenses are for procedures to be done this year and the next year, afterwards the amount spent on medical expenses will be less than the 7.5% of income required (no more procedures needed- otherwise healthy person).

Answer 1

You have substantial assets inside a tax-deferred traditional IRA and now you are facing a big tax bill when you take those required minimum distributions.

It is smart to see that those RMDs are going to bump you into a higher tax bracket and to plan ahead. You can start to draw the money out of your IRA as soon as you are 59.5. One strategy is to figure how much you can take out each year and not go into the next higher bracket, and take that out before age 70.5. You will not be paying higher tax on it, and it will reduce the balance in your account, and thus reduce your RMD.

If you do not need or want to move the money into an after-tax account or spend it now, you could figure the amount of withdrawal that doesn't bump you into another tax bracket, and move that amount into a Roth IRA each year. You will pay regular income tax on the rollover, but the amount rolled over plus earnings is tax-free when you take a distribution, and is not subject to RMD. You can do this as long as your AGI (before the IRA rollover) is under $100K. This restriction disappears in 2010.

A taxpayer with this problem should consider switching current contributions to a Roth rather than a traditional IRA, since the current deduction may not be much benefit, and you want to reduce the RMD in a few years.

Once you reach age 70.5 and are subject to RMD, if you make charitable contributions, do them as charitable rollovers from your traditional IRA. These charitable rollovers can be used for RMD and are tax-free.

If you plan on doing Roth rollovers, get them done before you start your Social Security benefits. Roth distributions do not increase tax on SS benefits. This is another reason to move as much as you can from your traditional IRA to your Roth IRA before the RMD and SS benefits begin.

Answer 2

Medical expense deductions don't stop just because you turn 70-1/2. That's the age at which you are REQUIRED to withdraw a certain amount each year from a traditional IRA, but it doesn't affect whether or not you itemize. But you are correct that taking money out in a year when your have additional deductions would result in less taxes for that year. If you had other taxable income for that year though, it wouldn't save anything in the long run since you'd get the deduction either way.

Answer 3

why do you think at waiting till 70 1/2 that you will not have the deduction benefit? If you have medical expenses, it doesn't matter what age you are, they are still deductible on Schedule A - Itemized Deductions - Line 1, and they have to exceed 7.5% of AGI. You also don't have to wait until age 70 1/2 to start taking IRA withhdrawal. You could basically start at 59 1/2 without paying additional 10% penalty. Also, anytime you take distribution from IRA it's taxable income. So if you took money from IRA at age 67 it's still taxable income.

Just to let you know though, for tax years beginning in 2006 & 2007 an individual may have up to $100,000 per year of your IRA balance distributed to a charitable organization without recognizing income on the distribution. You don't get a charitable contribution deduction though for the amount. But that is one way to get rid of some of the money in your IRA without paying taxes on it.

Answer 4

You are sort of on the right track, but the real object is to take withdrawals in a lower tax bracket, if possible. If the itemized medical deductions will put you in a lower bracket, you could withdraw or convert to ROTH an amount that would still keep you in that lower bracket.
Also, with or without the deductions, make a forecast of your tax bracket at 70 1/2 with RMD's. If the RMD's will put you in a higher bracket, consider taking some out now and paying tax at the lower bracket.

Answer 5

Well, in my book, there's always a way. But to me, it depends on if you want to worry more about saving money on income tax or making more wealth, overall. I always tell my clients that you can't let the tax "tail" wag the wealth "dog." Sure, you can do the basics, like maximizing contributions to your tax-deferred retirement plans and getting married and having little tax deductions running around the house. But are you going to do that just for the tax savings? I don't think so. (Well, maybe the retirement things you might). You're probably at the peak of your earning power. Maximize that! You'll not pay more than a third of your income in tax. So the question is, if you have an hour right now, are you better off using that hour to SAVE $100 on your taxes, or to EARN $400 more income? Some hours you may have a different answer than others, and that's OK! -- A Damn Fine Tax Advisor

Answer 6

Converting the same amount to a Roth IRA would offer the same tax benefit (allowing you to offset it with medical expense deductions) and would make the future earnings tax-free.

Answer 7

Give it away.

That is about the only way to reduce taxes on IRA income.

Answer 8

it's all normal income once you start withdrawing, nothing you can do to change that