Avoiding The IRA Waterfall: 4 More Ways To Increase The After-Tax Value Of Your IRAs
By: Bob Carlson - July 20, 2018
The bane of many retirements is the requirement to take minimum distributions from their IRAs and other qualified plans after reaching age 70½, as I said in my last post. The rule often triggers additional taxes and penalties on retirees, reducing the after-tax value of their IRAs.
Here are four more strategies for you to consider that might reduce the burden of RMDs.
Qualified longevity annuity contracts. RMDs can be delayed when the IRA purchases a qualified longevity annuity contract (QLAC). The portion of the IRA that’s invested in a QLAC isn’t included when computing RMDs.
A QLAC is a deferred annuity contract. You give a deposit to an insurer, and it promises to make a specific annual payment to you each year for the rest of your life, beginning in a year you select. The payments can be delayed from two years to 45 years after you buy the annuity, but they have to begin by age 85.
The QLAC can be used for the lesser of 25% of your IRAs or $125,000. The limit is per person, not per IRA.
If you’re inclined to buy a QLAC, it’s probably best to move the money into a separate IRA that owns nothing except the QLAC. That will simplify your annual RMDs and IRA management.
The charitable exclusion. The qualified charitable distribution exclusion was made a permanent part of the tax law in late 2015.
A taxpayer age 70½ or older can have money transferred directly from a traditional IRA to a public charity. The distribution is treated as part of the individual’s RMD for the year, but it isn’t included in his gross income. The IRA owner receives no charitable contribution deduction.
This strategy probably is valuable to more people after the Tax Cuts and Jobs Act, because the higher standard deduction means fewer people will be itemizing expenses and taking charitable contribution deductions. The qualified charitable contribution exclusion might be the only tax-advantaged way for some people to make charitable contributions after 2017.
The qualified charitable distribution exclusion is limited to $100,000 per taxpayer per year.
Timing the first RMD. The first RMD has to be taken by April 1 of the year after you turn age 70½. Technically, however, the RMD is for the year you turn 70½. For many taxpayers, it makes sense to take that first RMD by December 31 of the year they turn 70½ so they don’t have two RMDs bunched in the next year.
Suppose Max Profits turns 70½ in July 2018. He doesn’t have to take that first RMD until April 1, 2019. But he’ll also have to take his 2019 RMD by December 31, 2019. If he waits until 2019 to take the first RMD, he’ll have two RMDs on his 2019 tax return. That could push him into a higher tax bracket or trigger some of the Stealth Taxes that kick in at higher incomes. He might be better off taking the first RMD by December 31, 2018.
Avoiding the RMD Waterfall. The first RMD is 3.6% of the IRA balance, using Table III of the life expectancy factor tables. The percentage of the IRA required to be distributed increases each year. Many people find that in their late 70s or early 80s the RMD rules force them to distribute and take into gross income far more money than they need or can spend. At age 80, 5.25% of the IRA must be distributed, and at age 85 you must distribute 6.76%.
That’s why I say the RMD tables create an RMD Waterfall. The percentage of your IRA that must be distributed increases each year, and if you’re investing well the dollar amount of the RMDs increases significantly over time. Your gross income increases more and more each year. This triggers higher taxes.
People who have sufficient retirement income and assets outside their traditional IRAs find the IRA Waterfall is burdensome.
Fortunately, there are ways to reduce the IRA Waterfall.
One simple strategy is to empty your IRA early. Take distributions before age 70½ and pay the taxes on them. Then, reinvest the after-tax proceeds in a taxable account. In the future you’ll be able to control when taxes are due and can invest in tax-advantaged ways, such as for long-term capital gains, qualified dividends and tax-free interest.
You also could convert some or part of the traditional IRA to a Roth IRA. You’ll pay taxes by including the converted amount in gross income. But RMDs aren’t required from a Roth IRA. Also, income and gains will compound tax-free in the Roth IRA and, after a five-year waiting period, will be tax free when distributed to you or your beneficiary.
Another strategy is to take the money out of the IRA, pay the taxes, and put the rest of the money into a charitable remainder trust. The trust will pay you income for life, and a charity you select will receive the remaining trust property after you pass away. You’ll receive an income tax deduction for the present value of the charity’s remainder interest when you contribute money or property to the trust, and that will offset some of the taxes owed by taking the distribution from the IRA.
Someone who doesn’t need the income now and wants to maximize the legacy for heirs can use life insurance. Take a distribution from the IRA and use the after-tax amount to buy a permanent life insurance policy. The heirs are likely to inherit more after taxes than they would by inheriting the IRA, and you’ll avoid RMDs for the rest of your life.
Article Source: Forbes
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