Minimize the Impact of Required Minimum Distributions (RMD)
From: newretirement.com
When we reach the age of 70 ½ we must — in order to avoid tax penalties — take Required Minimum Distributions (RMD s) from IRAs, 401ks and other types of tax advantaged accounts — all retirement accounts funded with pre-tax contributions.
So what exactly is a “Required Minimum Distribution?” Let’s break it down:
- Required — The dictionary defines “required” as deemed to be necessary. And, indeed it is highly recommended that you make these withdrawals. If you do not, you will be charged hefty penalties.
- Minimum — You don’t need to withdraw all your money — just an amount determined by an I.R.S. formula involving the value of your account, estimated returns and your life expectancy. The exact distribution amount changes from year to year.
- Distribution — Distribution is just another word for withdrawal.
So, RMDs are withdrawals of an amount that is determined by the I.R.S. that you really should make every year after turning 70.5 in order to avoid penalties.
However, these annual distributions are fully taxable at ordinary income tax rates. Therefore, RMDs, and the associated taxes, can seriously erode your wealth. It makes sense to look at ways to minimize taxes where you can.
Why Are RMDs Required?
Required minimum distributions are the government’s way of recovering the tax breaks on the initial contributions to your retirement account and the years of tax-deferred wealth.
6 Ways to Lessen the Impact of RMDs
For some retirees these distributions are an essential part of their retirement income. For others, they have other sources of income and don’t need some or all of the amount of these distributions.
If the RMD is not needed it behooves you to look at strategies to minimize the amount of the distribution or defer it and the accompanying tax hit. These strategies should be viewed in the overall context of your retirement plan, tax avoidance is a tactic not an objective unto itself. If appropriate for your situation, one or more of these strategies could help you optimize your wealth.
Here are 6 ways you can minimize the impact of your withdrawals:
1. Qualified Charitable Distribution (QCD): In 2015 Congress finally made QCDs a permanent part of the tax code. QCDs are a valuable tool for those who are at least 70 ½, do not need to use the money themselves and who have charitable inclinations.
The QCD rules allow you to donate up to $100,000 of your RMD to a qualified charitable organization. The amount given to the charity is not taxable, though there is no additional deduction for the charitable contribution. QDCs will lower your tax hit and allow you to fulfill your charitable intentions at the same time.
2. QLACs: QLAC stands for Qualified Longevity Annuity Contract. QLACs can be purchased within an IRA or 401(k) account and allow the account holder to delay RMDs until as late as age 85. A QLAC is a newly-created product that is a fixed-rate deferred annuity, and payments can begin at any age up to age 85. Those who purchase a QLAC can use it in conjunction with their employer-sponsored 401(k) or other qualified plan and start receiving payments much later in life than other investment products allow.
Potentially a good idea in theory, using it to defer RMDs may or may not be a good idea in reality. While nobody likes the idea of paying taxes on their RMDs, the bigger issue is whether this will be beneficial to you over time in terms of your overall retirement planning.
A thorough analysis should be done prior to going ahead with a QLAC or any other annuity product.
