3 Tax-Planning Ideas to Help Take the Bite Out of RMDs
Required minimum distributions can be the bane of many IRA owners' existence. But there are a few creative ways to reduce your income tax burden, or that of your heirs.
It is that time of year. RMD season is in full swing, with the Dec. 31 deadline fast approaching for those who are 70½ and have IRA money that they have to withdraw or face the 50% IRS penalty. Besides, with the stock market reaching new highs, now could be a good time to take your required minimum distribution.
But before making that withdrawal, consider these three tax-planning possibilities:
1. Gifting required minimum distributions to a qualified charity.
For those over age 70½, a required minimum distribution is not counted as taxable income for federal income tax purposes if paid directly to a qualified charity. That’s referred to as a qualified charitable distribution (QCD). Currently the limit is $100,000 per taxpayer per year. This may be especially helpful to those who want to keep their adjusted gross incomes lower, because the withdrawal is not counted toward their AGI. That’s important because AGI affects your ability to take itemized deductions, eligibility for Roth IRA contributions, taxes on Social Security and Medicare premiums, among other things. IRA owners with pretax contributions receive the QCD treatment, while non-deductible contributions are not eligible for the QCD. Ideally, the charity should receive the cash by Dec. 31.
2. Qualified Longevity Annuity Contracts.
Buying a QLAC in an IRA means that money used to purchase the annuity is excluded from the RMD calculation until age 85. For instance, if an IRA owner has total assets of $500,000, but purchases a QLAC for the maximum $125,000, the QLAC is excluded from the RMD calculation. In this example, the RMD calculation is based on $375,000 not the full value of the IRA the $500K. Using the Uniform Lifetime Table, the RMD for a 70 ½-year-old with a $500,000 IRA is $18,248, vs. $13,686 for the IRA with the QLAC, an RMD savings of almost $5K. So, basically, with this strategy you are putting off paying income tax on a portion of your IRA money. Though the return rates on QLACs are currently low, this strategy may make sense as part of a diversified portfolio.
3. Using IRA RMDs to purchase life insurance.
If there is no current need for an IRA RMD, then rather than reinvesting the withdrawal, consider magnifying the distribution for your heirs by purchasing a life insurance policy. For example, a 71-year-old man who uses his RMD of $12,000 can purchase a universal life guaranteed death benefit from a conservative company delivering a payout of $315,032. That would be a return if he dies in year one of 2,525%, or a 6.7% return at age 86 if he continued to use his RMDs to fund the policy each year, on a guaranteed income tax-free basis. Consider also if this 71-year-old man instead purchased a survivorship policy for himself and his wife. The $12,000 RMD buys a $533,296 death benefit (which pays out after the second death). While it's unlikely both the husband and wife would die in year one, if they did, this would represent a 4,344% return. And, at the wife’s age 87, if both were to pass, it would offer a tax-free return of 11.2%. Very compelling indeed. Life insurance death benefits are income-tax free and, with proper planning, potentially estate tax free.
These three tools can help take the sting out of required minimum distributions.
About the Author
CFP®, Summit Financial, LLC
Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC. Investment advisory and financial planning services are offered through Summit Financial, LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Legal and/or tax counsel should be consulted before any action is taken.