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What You Need to Know

  • There are a number of strategies that can reduce or defer your client’s RMDs.
  • These strategies should be evaluated in the context of your client’s overall financial planning situation.
  • Their tax situation and whether or not they need money from the RMDs are key factors to consider.

As we approach the end of 2021, it’s important to be sure that all clients have taken their full required minimum distributions (RMDs) for the year. As you are certainly aware, there is a 50% penalty on any RMD amount not taken by the deadline.

Beyond just managing RMDs, there are a number of planning issues surrounding RMDs not only for clients who must take them, but also for younger clients as they approach age 72. 

Much of this planning centers on: 

  • Your client’s current and anticipated future income and tax brackets.
  • Whether your client needs the money from the RMDs. 

For many clients, there are steps that can be taken this year and in future years to reduce their RMD obligations from traditional IRAs and other retirement accounts, if this makes sense from an overall planning perspective. 

Qualified Charitable Distributions (QCDs) 

Qualified charitable distributions or QCDs allow those who are at least age 70½ to take up to $100,000 from their traditional IRA and direct it to qualified charitable organizations. 

The benefit is that QCDs are not taxed. As far as RMD planning goes: 

  • QCDs taken prior to age 72 will reduce the amount in the traditional IRA that is subject to future RMDs.
  • QCDs taken in excess of a client’s RMD amount on or after age 72 will serve to reduce the amount of future RMDs.
  • Using QCDs for some or all of a client’s RMD will reduce the amount of the RMD that is taxable, while accomplishing the client’s charitable giving goals. 

QCDs are an excellent tool for those who are eligible and who are charitably inclined. For clients in this situation who can’t itemize deductions, QCDs can be a tax-efficient method of making charitable donations while at a minimum reducing the tax bite of their RMDs. 

Roth Conversions 

Roth IRAs and Roth conversions have been in the news a lot lately. A Roth IRA conversion can be a solid overall planning tool, including as a vehicle to manage and reduce future RMDs. 

Money converted to a Roth IRA, along with future earnings on that money, is removed from the pool of funds that are subject to RMDs in future years. If a client is already taking their RMDs, all RMDs must still be taken in the current year; doing a Roth conversion does not reduce any part of their RMD obligation in the year of the conversion. 

The decision as to whether or not a Roth conversion is right for your client should be done in the context of their overall financial planning objectives. Considerations include: 

  • Current-year income and taxes. Years in which your client’s income is lower than normal can be good years to consider a Roth conversion. This might include the period after the client has retired but has not yet commenced taking Social Security benefits. Clients in this “gap” period often find themselves in a lower tax bracket than in other years.
  • Are there potential non-spousal heirs to their IRA? If so, a Roth conversion can save these heirs on potential taxes after inheriting the IRA. The analysis should look at the overall family tax situation to see if it makes sense for your client to essentially prepay taxes for the next generation.
  • Does your client need the money from the RMDs on the traditional IRA? If not, then paying the taxes now in exchange for the ability to allow the converted Roth funds to continue to grow tax-free could be a good trade-off. 

Roth Contributions

Contributing to a Roth IRA or Roth 401(k) can be a means for clients to limit future RMDs. Contributions to a Roth 401(k) can be especially useful here, as there are no income limitations on their ability to contribute and the contribution limits are higher than for a Roth IRA. 

Money held in a Roth IRA is not subject to RMDs. Money in a Roth 401(k) is subject to RMDs, though they are not taxed. This can be avoided by rolling the Roth 401(k) account balance over to a Roth IRA when leaving that employer. 

Money in a Roth IRA is not only exempt from RMDs for the account holder, but also for their spouse if they inherit the Roth IRA. Additionally, Roth IRA money inherited by non-spousal beneficiaries will not be taxed if certain conditions are met.  

The trade-off for your client is between the tax benefits of making pretax contributions into a 401(k) or traditional IRA now versus making after-tax contributions and being able to withdraw funds tax-free in retirement, and having the option to simply let this money grow tax-free in the Roth IRA. 

Qualified Longevity Annuity Contracts (QLACs)

QLAC stands for qualified longevity annuity contract. QLACs are annuities that can be purchased only with assets from a retirement plan such as a traditional IRA, 401(k) 403(b), 457(b) or similar retirement plan. The maximum that can be contributed to a QLAC from all accounts is $135,000. 

Income from a QLAC can be deferred to age 85. This also serves to defer, but not eliminate, the RMDs on this money until your client begins taking distributions from the QLAC. 

The main benefit of a QLAC is that it allows your client to defer some of their retirement account balance into the future before taking the annuity payments. This can help clients preserve this money for the latter part of their retirement. Deferring RMDs is a side benefit here. The key decision is whether a QLAC is right for them and if so, selecting the best QLAC annuity provider for them. 

Working at Age 72 and Beyond

Clients who are working at age 72 or beyond can defer their RMDs associated with the 401(k) or other employer-sponsored retirement plan under the “still working” exception. As long as they do not own 5% or more of the company, and if the company has incorporated this option into their plan documents, then employees can defer RMDs on money held inside the plan as long as they are employed by the company. 

This RMD exception does not apply to money in an IRA or any other retirement plan outside their current employer’s plan. 

In some cases, it might make sense to move money from a client’s IRA or an old 401(k) plan into the current employer’s plan in a reverse rollover, if the plan allows this, to take advantage of the RMD deferral on these funds.

The reverse rollover should be done only if the current plan’s investment options are solid and low-cost. The benefits of deferring RMDs can quickly be negated if the current employer’s plan is a poor one. The source of the money rolled into the plan must be the same as the money in the current plan — for example, pretax contributions. 

Overall, deferring or reducing your client’s RMDs can be a positive strategy for them. But the decision as to whether to undertake any or all of the strategies that can accomplish this should be looked at in the context of your client’s overall tax and financial planning situation. 

Roger Wohlner is a financial writer with over 20 years of industry experience as a financial advisor.