Retirement Watch Lighthouse Logo

How to Trim Taxes and Maximize Benefits from RMDs

Last update on: Jun 22 2020

Last week, I shared   4 ways to trim taxes, and maximize required minimum distribution (RMD) benefits. This week, let’s continue the discussion, with 5 more strategies to consider, starting with..

Timing distributions.

The tax law says the IRA must distribute at least the RMD by the close of business on Dec. 31.

Other than that, you can schedule distributions however you want.

A few years ago, a study by T. Rowe Price concluded that an IRA lasted longer when RMDs were delayed until late in the year.

That’s because a majority of the IRA was invested in stocks, and stocks were in a bull market during the period of the study.

Delaying distributions until late in the year let more appreciation compound in the IRA.

But if stocks weren’t doing as well, delaying distributions wouldn’t be as beneficial.

Also, the difference would be much less if the IRS distributed assets that stayed invested in a taxable account, after paying taxes.

I generally encourage people to take RMDs early in the year to ensure nothing during the year prevents a distribution.

Remember, in the year a person passes away, the RMD still has to be taken.

Often that doesn’t happen and the estate pays a penalty for not taking the RMD.

Also, if you convert a traditional IRA to a Roth IRA during the year, the RMD still has to be taken from the traditional IRA.

In fact, the RMD has to be taken before the conversion takes place.

Qualified longevity annuity contracts.

RMDs can be delayed when the IRA purchases a qualified longevity annuity contract (QLAC).

The portion of the IRA that is invested in a QLAC isn’t included when computing Required Minimum Distributions.

A QLAC is a deferred annuity contract. You give a deposit to an insurer, and it promises to make a specific annual payment to you each year for the rest of your life, beginning in a year you select.

The payments can be delayed from two years to 45 years after you buy the annuity, but they have to begin by age 85.

The QLAC can be used for the lesser of 25% of your IRAs or $125,000. The limit is per person, not per IRA.

If you’re inclined to buy a QLAC, it’s probably best to move the money into a separate IRA that owns nothing except the QLAC. That will simplify your annual RMDs and IRA management.

The charitable exclusion.

The qualified charitable distribution exclusion was made a permanent part of the tax law in late 2015.

A taxpayer age 70½ or older can have money transferred directly from a traditional IRA to a public charity.

The distribution is treated as part of the individual’s RMD for the year, but it isn’t included in his gross income. The IRA owner receives no charitable contribution deduction.

This strategy probably is valuable to more people after the Tax Cuts and Jobs Act, because the higher standard deduction means fewer people will be itemizing expenses and taking charitable contribution deductions.

The qualified charitable contribution exclusion might be the only tax-advantaged way for some people to make charitable contributions after 2017.

The qualified charitable distribution exclusion is limited to $100,000 per taxpayer per year.

Timing the first RMD.

The first RMD has to be taken by April 1 of the year after you turn age 70½.

Technically, however, the RMD is for the year you turn 70½.

For many taxpayers, it makes sense to take that first RMD by Dec. 31 of the year they turn 70½ so they don’t have two RMDs bunched in the next year.

Suppose Max Profits turns 70½ in July 2018. He doesn’t have to take that first RMD until April 1, 2019.

But he’ll also have to take his 2019 RMD by December 31, 2019. If he waits until 2019 to take the first RMD, he’ll have two RMDs on his 2019 tax return.

That could push him into a higher tax bracket or trigger some of the Stealth Taxes that kick in at higher incomes.

He might be better off taking the first RMD by December 31, 2018.

Avoiding the RMD Waterfall.

The first RMD is 3.6% of the IRA balance, using Table III of the Life Expectancy factor tables. The percentage of the IRA required to be distributed increases each year.

Many people find that in their late 70s or early 80s, the RMD rules force them to distribute and take into gross income far more money than they need or can spend.

At age 80, 5.25% of the IRA must be distributed, and at age 85 you must distribute 6.76%.

That’s why I say the RMD tables create an RMD Waterfall.

The percentage of your IRA that must be distributed increases each year. If you’re investing well, the dollar amount of the RMDs increases significantly over time.

Your gross income increases more and more each year. This situation triggers higher taxes.

People who have sufficient retirement income and assets outside their traditional IRAs find the IRA Waterfall is burdensome.

Fortunately, there are ways to reduce the IRA Waterfall. Here are some of the ways to combat this.

Take money out of the IRA before you are required to, and the earlier the better. When a traditional IRA is primarily emergency savings or intended for heirs, it might create more after-tax wealth if all or a large portion of it is taken out early, the taxes paid, and the after-tax amount invested for the long term in tax-advantaged ways.

Convert the traditional IRA to a Roth IRA. Pay the taxes now, avoid the future RMDs, and have the benefit of tax-free investing and future tax-free distributions from the Roth IRA.

Let the RMDs happen, but use the after-tax amount to purchase permanent life insurance. Your heirs inherit the insurance benefit tax-free, and it is likely to be much higher than the after-tax amount of the IRA would be.

Use the Family Bank Strategy. Draw down the IRA early, pay the taxes, and use the after-tax amount to buy a permanent life insurance policy that will serve as a family bank.

You can tap the cash value for tax-free loans if you need cash. Otherwise, your heirs inherit the life insurance benefit.

bob-carlson-signature

Retirement-Watch-Sitewide-Promo

Log In

Forgot Password

Search