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Working With RMDs

Many of us spend the majority of our working lives stashing money aside in a variety of retirement funds, just waiting until we’re able to finally enter our Golden Years. But did you know that you can’t keep your retirement funds in those accounts indefinitely? In general, you have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA or retirement plan account when you reach the age of 70 ½. The minimum amount you must withdraw is known as the required minimum distribution, or RMD. These withdrawals will be included in your taxable income, except for any part that was taxed before, or those that can be received tax-free, like qualified distributions from designated Roth accounts. Failure to take these distributions can result in hefty penalties.

For some retirees, the need to withdraw these RMDs is unnecessary and can often generate high income taxes for the year. Fortunately there are a few ways to minimize your RMDs, and even get around them in some cases. Here’s a look at these options, as recently reported on in a Madison.com article.

Qualified charitable distribution

Reducing your tax bill through a charitable distribution is a common strategy used by those who plan to give to charity anyway. A qualified charitable distribution is a transfer of funds from your IRA directly to any charity that qualifies for the charitable deduction. You are permitted to transfer up to $100,000 per year with this option. These distributions count toward your RMD for the year, but are not subject to the same income taxes. This is a great strategy for retirees who don’t need as much money as the RMD requires, but are interested in donating to a cause while avoiding the extra income taxes.

Qualified longevity annuity contract (QLAC)

Annuities can be a great tool for many retirees. Because many offer guaranteed income for life, they ensure that you won’t run out of money. A deferred annuity is a contract in which you give your money to an insurance company without receiving payments until a predetermined date. The longer you wait to start receiving payments, the bigger those payments will be relative to your investment.

If you use your IRA funds to buy a deferred annuity, they will count towards your RMD calculation even though the money will be tied up with the insurer. In other terms, your RMD won’t drop despite the fact that you’ve reduced the amount of money in the account. The QLAC rules were designed to get around the RMD conundrum. Up to 25% of your IRA balance can be held in an annuity, and the proposed annuity payments will count toward your RMD for the year, even if the payments haven’t started yet.

One of the drawbacks of a QLAC is that if you choose a long deferral period, you might not live long enough to break even on your investment. You will also lose out on the gains the money could have earned if left invested in your IRA. A QLAC can still be a great tool for some, but it’s important to do some number crunching before signing on the dotted line.

Roth IRA

Another way to save some money on RMDs is by keeping a portion of your money in a Roth IRA as opposed to a traditional IRA. When calculating your RMD for the year, you only have to consider the funds in tax-deferred accounts and employer-sponsored accounts, like 401(k)s. Anything in a Roth IRA doesn’t count. If you don’t have a Roth IRA, it’s not too late to do a conversion and move some money into one. Be aware though, when you make such a conversion, you’ll be required to pay taxes on the money you’re rolling over. Again, it is crucial to do the math before making the commitment. If the taxes on a one time conversion are too steep, you can consider spreading it out over several years to reduce the tax costs for any given year.

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