In his 1998 book “The Prosperous Retirement,” Michael Stein wrote that as people begin to age and become less active, they scale back their discretionary spending. It is a key feature of what he called the “slow-go” stage of retirement.
Fast forward more than 20 years, and that observation still holds. Think about it: For a retiree in their 70s, weeks that were perhaps once consumed with eating out, multiple rounds of golf or trips to Home Depot are now far more likely to include downtime, less physical activity and more home-cooked meals.
For advisors with retiree clients, this can be a double-edged sword. On the one hand, any time a client spends less money, it’s naturally going to be easier for them to stay on track to meet all their goals. On the other, once they hit 70.5, they must take required minimum distributions (RMDs) from their qualified accounts, which even as they do not need that extra income could result in more significant tax liabilities.
How RMDs Create Complexity
Let’s imagine a hypothetical 71-year-old client who estimates he and his wife need about $75,000 annually for living expenses in retirement. They get $45,000 from Social Security, with the other $30,000 coming from a pension. Up until now, this has been a good arrangement because, as a married couple filing jointly, their tax obligations have been minimal at that amount of income.
However, things will soon become complicated because he also has a traditional IRA worth $700,000 that up to this point has gone untouched. Since he is over 70.5, he will be obligated to take an RMD from that account, which based on his age and the size of the IRA will be about $26,400, boosting their combined income to just over $100,000.
At that level, they will leap into a higher tax bracket (going from 12% to about 22%), which will force them to pay about $5,800 in additional federal taxes — all despite not needing the money.
There is potentially another big problem with RMDs for a couple like this. If one of them were to pass away, the other’s Medicare premiums and federal tax rates could go up even further since their income would rise while deductions they could take as a single filer would go down. And because RMDs increase each year, this would be an ongoing issue for the surviving spouse.
Charity as the Possible Solution
To avoid a situation like this, talk to clients about the potential benefits associated with converting a portion or even all their annual RMDs into qualified charitable distributions (QCDs), which are not taxable. These types of donations could help clients like this minimize their tax bill and are an approach that is consistent with the philanthropic instincts that are innate to many Americans.
Indeed, in 2017, 71% of baby boomers made charitable donations, which means many of your retiree clients are likely already supporting causes that are near and dear to their hearts. QCDs could be just a different, more tax-efficient way for them to do so.
Before pursuing this route, there are three things advisors need to keep in mind:
- Involve your client’s tax professional. Typically, an IRA account custodian will not report which portion of a client’s RMD is going to charity. It is, therefore, essential to work closely with your client’s tax professional (if you are not tax credentialed yourself) to ensure this strategy is executed correctly. At the same time, because this approach is highly situational, it could be possible that using RMDs this way may not produce a meaningful benefit — which further highlights the importance of always keeping an open line of communication with a client’s other service providers.
- Help clients select a charitable organization that will do the most good. Many older clients may not take the time nor do they know how to research whether a charity really lives up to its stated purpose. Does it spend money and devote resources to programs that make a difference? Or is it bogged down with high administrative and staffing costs? These are things you can investigate for them. Finding out is as simple as visiting a website such as CharityWatch, which evaluates and grades charities in part based on these criteria.
- Keep track of the money and gather the receipts. Pay special attention to which charitable organization got what. This may sound simple, but it can get complicated if a client decides they want to spread their money around to different causes. Also, encourage clients to both request and to keep receipts confirming their donations, and then to share them with whoever prepares their taxes.
As more and more baby boomers retire, an increasing number of advisors will have clients who must contend with the tax implications of having to take an RMD, even as they may not need the money. Qualified charitable distributions are one way to overcome this hurdle, while also tapping into a client’s philanthropic impulses.
Corey Keltner is a practice development specialist at Securities Service Network LLC, a Knoxville, Tennessee-based subsidiary of Ladenburg Thalmann Financial Services.