Handling Large IRAs Under the New Tax Act: 3 Things to Consider
From: www.horsesmouth.com
IRA distribution planning is becoming a high-stakes game for clients in more ways than one. Gone are the days when simply dropping dollars into a traditional IRA was the sensible thing to do.
IRA distribution planning is entering a new world, a departure from the days when simply dropping dollars into a traditional IRA was the sensible thing to do. With the growing complexity of the new tax act, and the substantial growth of clients’ IRA accounts, distribution planning is becoming a high stakes game for clients in more ways than one. We review below three things to consider on behalf of every client that owns a large IRA.
1. QCDs for getting around RMDs
A traditional IRA is, well, traditional, and is the more common type of IRA used. Traditional IRAs allow for deductions on contributions when made, which helps decrease the client’s tax burden, but requires taxes on distributions in retirement, which obviously decreases after-tax funds in retirement.
The real issue with traditional IRAs are those pesky required minimum distributions, or RMDs, the first of which must be taken by April 1 of the year after the year in which the holder of the IRA reaches 70½. RMDs are becoming more and more of a problem as clients accumulate large IRAs which then trigger large RMDs which then trigger additional (and substantial) taxes and surcharges in retirement. For example, the RMD on a $1 million account for an 80-year-old client is $53,476, which is a lot in and of itself. But combine years and years of RMDs and the resulting taxes, and the cumulative total just keeps climbing.
Thankfully, there is no change on IRA charitable transfers. This makes qualified charitable distributions, also known as QCDs, a handy way to get around the RMDs. Retirees 70½ and older can donate IRA assets up to $100,000 directly to charities and have the donations count toward their RMD. For those IRA owners who give to charity, this is often a tax-efficient move, as the donor can take the standard deduction, (as opposed to itemizing), and reduce their taxable income even further when donating to charity.
2. Roth IRAs for maximizing after-tax income, protecting and shifting wealth
Roth IRAs don’t give the contributor an initial tax deduction but have more potential long-term benefits in part because there are no RMDs to manage. This means that future tax-free withdrawals taken from Roth IRAs won’t push the holder of the account into a higher tax bracket or trigger higher Medicare surcharges. That is a definite benefit as exceeding Medicare income thresholds by even $100 can end up increasing annual premium by thousands.
An individual with income just $1 over $160,000 can expect to pay an annual Part B Medicare premium of $4180 versus $1608 per year. That is a surcharge of at least $2500, and it can get progressively worse at higher incomes because of the cascading effect of the additional taxable income. Limiting taxable income is more important than ever, now that the threshold for deductible medical expenses for those under 65 has been increased from 7.5% to 10%. This means that at $160,000 of income, you will need to have $16,000 of medical expenses before you can even consider deducting them, thereby driving up taxes even further.
