Some things about RMD’s are simple, such as the need to take them. But complexity can be your friend, when trying to minimize the impact of RMD’s on your family’s financial future.
What Is An RMD?
To the uninitiated, “RMD” is short for “Required Minimum Distribution.” An RMD is the amount of money the IRS requires people to distribute from certain retirement accounts each year. If you have a retirement account, you will likely one day be impacted by RMD’s.
Required Minimum Distribution requirements are an important piece in your retirement plan. Click here to learn how to strategically distribute your RMD.
In this article, we discuss unique strategies to deal with RMD’s, to give you a leg up.
The whole idea behind RMD’s from the government’s point of view, is to eventually collect some tax revenue from money that has spent most of it’s life growing tax-deferred. But just because RMD’s are considered “taxable distributions”, does not mean that you will have to pay taxes on them. Depending on the type and amount of other income you have for the year, sometimes RMD’s can be tax-free to you. RMD’s can also be used to create a tax-free inheritance for your heirs, instead of a retirement account laden with tax liability.
1. In-Kind Distribution
One of the unique strategies to take an RMD is by using an “in-kind distribution”. To help explain this strategy, we will use some examples.
Let’s say you have gold or silver coins in your IRA. If you are required to take an RMD, but do not want to sell your precious metals, you can request an in-kind distribution of coinage. The trustee of your IRA will issue a 1099 showing the distribution, but you will still own the metals (albeit outside of your IRA). In this way, you can satisfy IRS requirements, but keep your metals.
This method would also work with securities, such as stocks, bonds, ETF or mutual fund shares. Keep in mind that you might still need cash to pay any tax (if any) resulting from the RMD. If you later sell the gold/stock/fund shares etc, you can realize either a taxable gain, or a tax loss, on the price variance since the RMD was taken. The benefit is, you can sell at the best time for you, instead of mandatory selling for the RMD.
2. Distribute to Charities
Another strategy is useful for those who have a habit of giving to their church, synagogue, or other charity. One of the ways you can distribute an RMD tax-free, is by instructing your IRA custodian to distribute the RMD directly to a charity of your choice.
If your RMD is $25,000, you would normally have to add $25,000 to your taxable income for the year, and pay tax on that additional amount. By giving your RMD directly to a charity, you can kill 3 birds with one stone.
Your desired $25,000 donation was made.
Your required $25,000 RMD was taken.
But, the $25,000 RMD was not considered taxable income to you.
This method is often more advantageous tax-wise, if you were planning to make one or more donations anyway. Some charities are able to offer tax credits as well, for any donations received. This can in turn supercharge the tax-effectiveness of your donation, and reduce taxes otherwise owed on other income.
3. Continue to Work
If you need the income from the RMD for living expenses, there isn’t much need for a strategy, as you would be taking the distribution anyway. But if you don’t desire or need the distribution, and are only taking it to satisfy IRS requirements, there are ways to avoid having to take the RMD in the first place.
Let’s say you are over 70½, and would like to stay active in some way in the work force. If your employer has a retirement plan at work, you can inquire about transferring other retirement assets into that account. As long as you are still working there and an active participant in the retirement plan, you do not need to take an RMD.
If you are forced out due to a mandatory retirement, other options still exist to postpone your RMD. If you start your own business of some sort (pick something you enjoy doing), or have a farm/ranch, you can install a retirement plan for your business/farm, and continue to postpone your RMD’s as long as you are actively involved and your plan allows it.
4. Transfer to Stretch IRA
If you find yourself inheriting an IRA or retirement account, you can use special rules regarding RMD’s to DECREASE any taxes you might otherwise be liable for.
Let’s say you inherit an IRA worth $200,000. If you receive the inheritance as a lump sum, the entire $200,000 shows up in a single year as additional (taxable) income. This might very well bump you into a higher tax bracket, causing you to lose 40% or more of your inherited account to federal/state income taxes.
But by transferring your inherited retirement account to a “Stretch IRA” , you are able to keep the balance largely intact and growing tax-deferred. From this new account, you will have to take an RMD, based on your life expectancy.
Depending on your age, and the earning power of the account, the amount you have to withdraw is often less each year than the account grows – which creates very little tax from year to year.
5. Set Up Irrevocable Life Insurance Trust
The Granddaddy of RMD strategies, which is also the most complex, provides an immediate way for beneficiaries to inherit the entire value of a retirement account tax-free, upon the death of the account owner.
This is most often used in cases of larger retirement accounts, where the tax implications can be somewhat daunting. An IRA of $1,000,000 might have an RMD of $42,000, for example, depending on the owner’s age. If the owner sets up an Irrevocable Life Insurance Trust (ILIT), and uses the RMD’s to fund premiums for a $1,000,000 life insurance policy owned by the trust, his beneficiaries will receive the $1,000,000 upon his/her death tax-free, whereas the retirement account assets would be greatly reduced by taxes, if received immediately.
As you can see, there are many things you can do to make RMD’s less painful, and even postpone them indefinitely past age 70 1/2. And, there are other times when using RMD’s can significantly reduce your taxes, as when inheriting retirement assets. We recommend discussing these options with the tax/financial/legal professionals you work with, who can help you apply any/all of these strategies to your personal situation, when the need arises.
*This article does not constitute tax or legal advice; please discuss your personal situation with a competent accountant or attorney.