What You Need to Know to Make Required Minimum Distributions Less Taxing

Those pesky RMDs can wreak havoc if you haven’t done proper tax planning. With the deadline just around the corner, it’s time to finalize your RMD decisions.

If you’re 70½ and required to take your annual RMD or face the 50% IRS penalty, you don’t have much time left to act. With the stock market at new highs, this might be the perfect time to take an RMD. However, before you do, consider three tax planning options, as detailed by Kiplinger in its recent article, “3 Tax-Planning Ideas to Help Take the Bite Out of RMDs.”

1. Gifting the RMDs to a qualified charity. If you’re over age 70½, a RMD isn’t counted as taxable income for federal income tax purposes, if it’s paid directly to a qualified charity. That’s referred to as a qualified charitable distribution (QCD). Currently, the limit is $100,000 per taxpayer annually.

This may be a big help to those who want to keep their adjusted gross incomes (AGIs) lower, because the withdrawal is not counted toward their AGI. That’s important because AGI impacts your ability to take itemized deductions, eligibility for Roth IRA contributions and taxes on Social Security, as well as Medicare premiums and more. IRA owners with pretax contributions receive the QCD treatment, but the non-deductible contributions aren’t eligible for the QCD. Optimally, 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. Therefore, if an IRA owner has total assets of $500,000 and buys a QLAC for the maximum $125,000, that QLAC is excluded from the RMD calculation.

In that example, the RMD calculation is based on $375,000, not on the full value of the IRA at $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. That’s an RMD savings of about $5K.

Thus, with this strategy you’re putting off paying income tax on a portion of your IRA money. Though the return rates on QLACs are low right now, this strategy may make sense as part of a diversified portfolio.

3. Purchase life insurance with IRA RMDs This is a viable option for reinvesting the withdrawal, if you are not in need of the RMD funds. It’s a good way to add to the inheritance you leave for loved ones. Life insurance death benefits are income-tax free and with the right planning, potentially estate tax free as well.

Before you run out of time, speak with your estate planning attorney to make sure that how you take your RMD aligns with the tax planning aspect of your estate plan.

Reference: Kiplinger (November 2017) “3 Tax-Planning Ideas to Help Take the Bite Out of RMDs.”