Shrink Your RMDs in 2021 and Beyond

People who don’t need income from their IRA, SEP and/or 401(k) are benefiting from this year’s waiver of required minimum distributions (RMDs). They’re reducing income taxes and preserving their plan assets.

But RMDs will return in 2021. Since retirees will be a year older than when they last took their RMDs, they’ll have to take out a slightly higher percentage from their retirement plans.

There’s one little-known way to reduce “RMD shock” in 2021 and beyond. That’s by placing some of your funds in a qualified longevity annuity contract.  A QLAC is a type of deferred income annuity designed to meet IRS requirements.  The money in a QLAC is excluded from assets on which future RMDs are calculated.

You pay a single premium and then choose when to start receiving a stream of lifetime income by age 85 at the latest.  Putting off RMDs lets you keep more of your retirement plan intact and tax-deferred. A QLAC saves up to one-fourth of the IRA for the future production of guaranteed income.

Postpone up to 25% of your RMDs for years

An IRA owner can place up to 25% of his or her IRA balance — up to $135,000, whichever is less — in a QLAC. What could that do for you? At age 75, $135,000 in a QLAC avoids $5,895 of taxable RMDs you’d otherwise have to receive. At 84, you’d avoid $8,710 of RMDs.

Postponing up to 25% of your RMDs is a great way to set aside a portion of your assets today, reduce RMDs beginning at age 72 and postpone receiving income from these funds. That way, you can get more income when you may really need it in your 80s and 90s. While this additional income in later years is fully taxable, other incomes might be reducing or dropping off at that time. Deductible medical or long-term care expenses then might offset the increased taxable income.

Few 401(k) plans allow QLACs.  However, if your employer’s plan allows in-service rollovers or if you have already separated from service, you can move money from your 401(k) or other retirement plan to an IRA and then set up the QLAC. 

Create more lifetime income

Delaying RMDs isn’t the only benefit. The biggest advantage is that you’ll create a larger stream of income you can’t outlive.

You don’t have to wait until 72 to buy a QLAC.  The earlier you purchase one, the longer you’ll get to build up principal and the bigger payout you’ll ultimately get.

Because you’ll have a new source of guaranteed income coming available at the time of your choosing, you may be comfortable taking more market risk with other assets in your plan in an attempt to earn higher returns.

Since the QLAC is a great deal for retirees who can afford to defer some income, the IRS imposes strict limits. It bears repeating: Over your lifetime, you cannot allocate more than 25% of the total of all your IRAs, or $135,000, whichever is less, in a QLAC.  The dollar limit is periodically adjusted for inflation.

Payout options for your QLAC

You can choose an individual or a joint lifetime payout, with the latter paying out income until the second spouse dies. The joint payee must be a spouse, which satisfies IRS death-transfer rules. There’s also a cash-refund option, in which beneficiaries can get a lump-sum payout for any of the initial deposit premium not yet paid out at the death of the annuitant(s).

The $135,000/25% limit applies to each account holder.  For example, John Doe has $600,000 in two IRAs. He can allocate up to $135,000 to a QLAC. His wife, Jane Doe, who has $350,000 in her IRA, can put up to $87,500 in a QLAC.

Finally, before you make the decision to purchase a QLAC, make sure you’re comfortable with the commitment. As with any deferred income annuity, you’re no longer in control of the principal in a QLAC. Your money is tied up because you made a deal with the insurer that gives you great benefits in return.