How to save when making required minimum distributions from retirement accounts.
Here’s a unique tax-avoidance strategy: Marry a younger person. The IRS says that if your spouse is at least 10 years younger than you, you’re entitled to take smaller required minimum distributions (RMDs) in retirement. You’ll owe less in taxes on those reduced distributions.
So you say that tactic isn’t in the cards? Then consider these other options:
Fund an annuity
With a longevity annuity, you pay a one-time, lump-sum premium, or periodic premiums early on. You then get guaranteed income later in life. The IRS currently exempts longevity annuity premiums of up to $125,000 or 25 percent of your IRA account, whichever amount is less. Traditional, SEP-IRAs, SIMPLE IRAs, and 401(k) plans are included, as are 403(b) and 457 plans.
Convert traditional IRAs to Roth IRAs
A good time to do that is when there’s a temporary dip in your income. If, for instance, you retire at age 66 but defer claiming Social Security till 70, your income in those four years could be smaller and subject to a lower marginal income tax rate than in later years when you have to start collecting Social Security and taking RMDs. Assuming you have enough other savings, use the opportunity to convert some IRA investments to Roths, paying at the lower tax rate. Later, when you must begin taking Social Security, you’ll have lowered your required minimum distributions and your overall tax bill.
Each year Gurwitz’s firm estimates for clients how much they’ll be able to convert to a Roth; he then goes as far as to set up two Roth accounts for each client, one filled with bonds and one with stocks. Before the tax return is filed, they review the accounts’ performances. Whichever account has gained more continues as a Roth account and the client pays taxes on its conversion. The other account is recharacterized before year-end as a traditional IRA, and no tax is due. Recharacterization requires some simple paperwork, nothing more.
Place your investments properly
Think of it as a tax portfolio. Taxable brokerage accounts are a good place to put some high-growth investments because long-term capital gains are taxed at favorable rates. Roths work for investments like equities that you expect to grow the most. IRAs are where you can locate slow-growth investments with reinvested dividends that won’t generate as much ordinary income tax when you take out your RMDs. “By overweighting bonds in retirement accounts, you’ll pay less tax because you don’t pay ordinary income,” Gurwitz explains.
Contribute to a charity
This tax break was available in 2014 and has since lapsed. However, it still could be available for tax-year 2015; lawmakers have acted to renew it several years in a row, typically in late December. Regardless of what they do, Michael Kitces, a financial planner based in Reston, Va., suggests investors should proceed:
“At worst, if the rules are not reinstated, the outcome will be no worse than just being forced to take an RMD and making a charitable contribution anyway (with the not-perfectly-offsetting tax deduction),” Kitces writes in a recent blog. “However, if the rules are brought back once again, those who make direct charitable distributions from their IRAs will enjoy all the benefits of QCDs … even if the rules are only ‘fixed’ after the fact!”
To perform that tactic, you must be 70½ or older. Ask your IRA custodian to make a distribution from your account and send it directly to a qualifying charity. (To identify qualifying charities, go to irs.gov and type “search for charities” in the search box.)
Folks age 70½ who don’t itemize their taxes stand to benefit the most from a QCD, mainly because they have fewer options than itemizers to search for tax savings, says Jeff Bucher, president of Citizen Advisory Group in Perrysburg, Ohio. The charitable contribution can be up to $100,000.
Another benefit: With a lower or no RMD, your modified adjusted gross income will be lower for the year, which may help you stay within income ranges to avoid surcharges on Medicare Part B and D premiums.
—Tobie Stanger (@TobieStanger on Twitter)
Article originally published at http://www.consumerreports.org/cro/news/2015/08/4-tax-smart-rmd-strategies/index.htm