Required minimum distributions, or RMDs, are the government’s way of forcing clients at age 70 ½ to begin drawing down tax-advantaged retirement accounts. Why? The U.S. government wants that tax money.
However, according to a Kiplinger’s Retirement Report piece by Editor Rachel L. Sheedy, there are ways to avoid those forced distributions or make the most out of them, either through better cash flow options or tax solutions.
Let’s begin with the ideas that can help clients find a way to avoid those RMDs:
- Work and roll: According to Kiplinger, if a client still works beyond the age 70 ½, and doesn’t own 5% or more of the company they work for, they don’t have to pay RMDs from that firm’s 401(k) until they retire. However, older 401(k)s are liable for the distribution. But there’s a workaround for that: Roll all the other accounts into the current company’s 401(k), if that is allowed, thus avoiding any RMD obligations until the client retires.
- Roth IRAs: There are a couple of ways these handy vehicles can aid in avoiding RMDs. First, is if the client is at least 59 ½ and has had an Roth IRA for at least five years, Roth 401(k) money can be rolled into a Roth IRA and it can be “tapped tax-free,” according to Kiplinger.
A second solution is to convert traditional IRA money to a Roth IRA. The client will owe taxes on the conversion at an ordinary income tax rate, but it reduces future RMDs.
- Carve-outs: A qualified longevity annuity contract, or QLAC, allows someone to carve out up to $130,000 or 25% of their retirement account balance and invest that money into a “special type of deferred income annuity.” A QLAC differs from other annuities because it requires a “smaller upfront investment for larger payouts that start years later. The money invested in the QLAC is no longer included in the IRA balance and thus is not subject to RMDs,” Sheedy writes. Payments from the QLAC are taxable, but those payments won’t “kick in” until age 85.
Another carve-out is if a client owns company stock in their 401(k). A strategy known as a “net unrealized appreciation” allows the client to split off employer stock and move it to a taxable account. This reduction of the 401(k) reduces the RMD amount.
- Younger spouse: If a client has a spouse who is 10 years younger, there is a way to divide the year-end account balance by melding the two ages and reducing the RMD. To determine this, Kiplinger recommends checking Table II of the IRS Publication 590-B.
- Pro rata payout: If a client can’t use any of the above ideas, it’s possible to reduce the tax bill brought on by the RMDs. Nondeductible contributions made into an IRA (records must be kept) will be tax-free.
Make RMDs Count