Required minimum distributions (RMDs) usually mean an increase in taxes. Here are four ways you can reduce this RMD burden for your clients.
1. Qualified charitable distributions (QCDs)
QCDs should be in play for every IRA client 70 ½ or older who is subject to RMDs and who also gives to charity. The QCD amount is excluded from income. This can create a chain reaction of tax savings since a lower income means more of the tax benefits, like deductions, exemptions and credits that would otherwise be reduced or eliminated due to higher income can now be retained. Increased tax deductions mean less income tax. The QCD option is only available for IRAs, not company plans.
We just saw a tax return where the reported RMD was $107,000. The return also included charitable contributions in excess of that amount that were claimed as an itemized deduction instead of using the QCD. It turned out that over $30,000 of the charitable deduction could not be taken due to the 50% income limitation. The excess gets carried over (but only for five years). If instead, that individual had used the QCD, he could have excluded $100,000 of that RMD (that's the annual QCD limit) and lowered his taxable income by over $30,000.
2. Qualifying longevity annuity contracts (QLACs)
QLACs actually have two benefits. One is that they can reduce the RMD amount and, in turn, reduce the tax bill. But a second benefit is that when the QLAC kicks in, usually at age 85, a client is protected from outliving their IRA money, at least up to the QLAC amount.
The QLAC value can be excluded from the retirement plan (including IRAs or company plans) account balance used for calculating RMDs. There are limits though. Retirement account owners can purchase QLACs of up to 25% of the account balance up to an overall maximum of $125,000. So a client with a $600,000 IRA is limited to a QLAC of $125,000. An IRA owner with $200,000 is limited to a QLAC of $50,000 ($200,000 x 25%). In either case, that's a nice chunk to chop off of an RMD calculation, not to mention the added benefit of longevity insurance.
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3. Rollovers to company plans
Not everyone can take advantage of this one, but if your client is subject to RMDs from his IRA and is also still working at a company with a 401(k) plan, a rollover to the company plan can delay future RMDs. To benefit from this roll-back to a company plan, you first have to make sure the company plan allows roll-ins from IRAs. RMDs from the plan can be delayed until retirement if the client does not own more than 5% of the company and if the plan allows this so-called "still working" exception for RMDs. Plans do not have to allow this, but many do. Before doing the roll-back to the plan, the current year RMD must be taken from the IRA. An RMD can never be rolled over. Once the IRA RMD is taken, then the balance of the IRA can be rolled over to the plan and IRA RMDs will be eliminated going forward. RMDs from the plan will be due for the year of retirement and later years, but the client may be in a lower tax bracket then.
4. Roth conversions
Roth conversions before reaching age 70 ½ will lower future RMDs, but what can you do once clients begin RMDs after age 70 ½? Those RMDs cannot be converted to Roth IRAs because a conversion is technically a rollover and RMDs cannot be rolled over. The first dollars out of the IRA are deemed to satisfy the RMD, but after that, the remaining IRA funds can be converted. That will actually increase the tax for the conversion year, but will reduce future RMDs. Over time, converting smaller amounts each year, filling up lower tax brackets, can reduce or even eliminate future RMDs.
Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.