How Required Minimum Distributions Can Increase Taxes on Social Security

Retirement savers usually have to begin taking required minimum distributions, or RMDs, at about age 73, although the exact starting age depends on birth year. Those withdrawals can quickly affect Social Security taxes.

Here is a look at how RMDs can influence your tax bill and a few steps that may help reduce it.

Understanding RMDs

The age at which RMDs begin depends on when you were born, but the formula for calculating the minimum withdrawal is the same. You divide the balance in retirement accounts that are subject to RMDs, as of Dec. 31 of the previous year, by the IRS life expectancy factor.

That factor declines as you age, which means the required withdrawal generally rises each year. For example, the IRS lists 20.2 as the life expectancy factor for an 80-year-old. If that person had $1 million in a traditional 401(k), the calculation would look like this:

RMD = $1 million / life expectancy factor

RMD = $1 million / 20.2

RMD = $49,504.95

RMDs do not apply to Roth accounts. They are required only from traditional accounts, such as traditional 401(k)s and traditional IRAs.

How the tax effect builds

Even a relatively small RMD can move you into a higher tax position, especially when it affects the combined income used to determine Social Security taxation. Once combined income passes a certain threshold, as much as 85% of your Social Security benefits may be taxable. For a single filer, that can happen above $34,000 in combined income, while married couples filing jointly face the same result above $44,000.

Combined income is calculated by adding adjusted gross income, tax-exempt interest and 50% of Social Security benefits. Because RMDs count as adjusted gross income, they can push the total higher.

Ways to reduce the tax hit

One possible strategy is to spread withdrawals across several years. Qualified charitable distributions can also direct part of your money to charity while lowering taxable income.

Qualified longevity annuity contracts, or QLACs, can push part of the tax burden farther into the future by allowing some RMD-related taxes to be deferred until age 85. That is when distributions from a QLAC must begin, though some people start sooner.

If you are still years away from the RMD age, Roth conversions may help. Converting a modest amount from a traditional 401(k) to a Roth IRA each year can distribute the tax impact over time and may lessen the effect on Social Security benefits once RMDs start.

Why skipping RMDs is a bad idea

Although RMDs can raise taxable income, failing to take them is even more costly. The IRS can impose a 25% penalty for missing an RMD, although that penalty drops to 10% if the error is corrected within two years.

The first RMD must be taken by April 1 of the following year. After that, each annual RMD is due by Dec. 31.

Estimating your future RMDs can help you decide how much to convert to a Roth each year and what other steps may be needed to limit the tax impact.