If you’re over the age of 70 or approaching your 70th birthday soon, you’re likely aware of the “birthday gift” you’ll receive from the IRS — your required minimum distribution (RMD). In most cases, once you turn 70½, you are required to start taking money out of IRAs, 401(k)s, and other qualified retirement plan accounts.
While RMDs can provide some helpful extra cash flow, they’re taxed as ordinary income and could bump you into a higher tax bracket than you’d like.
Fortunately, there are ways you can minimize taxes on your RMDs, which can help reduce the risk that you’ll find yourself in a higher tax bracket. Here are three simple ways to go about this:
Make a charitable donation.
You can use all or part of your RMD as a qualified charitable distribution and give up to $100,000 from your IRAs to charity, tax-free, every year. Essentially, this means you move money from your IRA to a qualified charity. (Learn about eligible charities or search the IRS qualified charity database at the IRS website). Have your IRA custodian transfer the funds from your IRA directly to the charity. If you skip this step, the IRS may not recognize the contribution, and you risk your RMD being taxed as income.
Buy longevity insurance.
If you’re worried about outliving your retirement savings, you could buy a qualified longevity annuity contract (known as a QLAC). QLACs begin paying out later than most annuities (generally between age 70 ½ and 80), and payments grow larger the longer you wait to take them. Under current IRS rules, you’re allowed to invest up to 25% of your IRA or 401(k) plan (or $125,000, whichever is less) in a QLAC without having to take RMDs on that money when you turn 70½. You’ll still have to pay taxes when you start receiving payments from the annuity, but you can delay payouts until age 85. If you choose to take this option, you’re killing two birds with one stone: helping protect against outliving your savings, while deferring the taxable distributions from your IRA.
Another item to note is that if you’re 70½ and still working, you may not be required to take RMDs from your employer’s 401(k). You will, however, have to take RMDs from previous employers’ 401(k) plans or traditional IRAs — but you can get around this by rolling those accounts into your current employer’s 401(k) before you turn 70½, if your company allows it. You’ll still have to take RMDs when you quit, but you’ll reduce or eliminate RMDs while you’re working, when your tax rate could be higher.
RMDs are a necessary part of life for most people over the age of 70 — but you can always plan to make the most of the situation. Do some research and explore your options. You can help manage the taxes on them so the money that you’ve worked hard for keeps working hard for you.