These days most of us know that contributing to pre-tax retirement accounts like IRAs and 401(k) plans allow us the ability to receive upfront tax deductions and to enjoy the tax-deferred growth as long as the investment remains in the account.
For those building retirement wealth and income, this compounding growth is powerful and allows us to plan for the future we really want.
However, to make sure that the taxes are eventually paid, the IRS mandates that retirement account owners begin liquidating those funds upon reaching age 70½.
For those who need the funds in retirement, it’s not a primary concern, but for those who don’t need the funds at that time, the Required Minimum Distribution (RMD) obligation that requires that some of that money be distributed and taxed can create a substantial tax challenge. RMD distributions may drive a retiree into a higher tax bracket when other retirement income is factored in.
It’s not possible to completely or indefinitely avoid the required tax payment, and beneficiaries will be subject to RMD obligations after the death of the original account owner, however, with specific strategies that tax burden can be lessened and/or delayed.
Understanding the Required Minimum Distribution (RMD)
Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires.
Whether you have just one IRA or many, the IRS will consider all of your qualified accounts to calculate your RMD annual payment. And, as long as you meet the IRS dollar requirement, you can take the distribution from a single IRA or from several different qualified accounts.
Strategies to Minimize Your RMD Tax Burden
It’s important to know all of the potential options to choose the best RMD strategy for your unique situation. Here are some annuity strategies for minimizing your tax burden when RMD distributions seem inevitable.
- Activate an Annuity Death Benefit Rider
If you’d prefer not to access your funds, and want to avoid RMD withdrawals, one strategy for leaving the bulk of your assets to your beneficiaries is to utilize a contractually guaranteed death benefit rider to a fixed annuity.
The accidental death benefit is payment due to the beneficiary of an accidental death insurance policy, which is often a clause or rider connected to a life insurance policy. The accidental death benefit is usually an amount paid in addition to the standard benefit payable if the insured died of natural causes.
This rider provides principal protection and a lasting legacy for your beneficiaries. Here’s an example of how it could work.
If you have $500,000 in funds in a traditional IRA that you do not need to live on during retirement, you can place that money instead in a fixed annuity with a contractual death benefit rider that guarantees growth of 5%.
While the initial investment of $500,000 grows at the compounded rate, the death benefit growth of 5% will offset the dollar amount of the required RMD. The sooner you start this activity before your 70th birthday the better, so that the initial investment can grow before you are required to start taking distributions.
This offset strategy allows you to take your RMDs while your initial IRA dollar amount remains fully intact for your listed beneficiaries and heirs.
Employ a Stretch IRA Strategy
If you structure your IRA strategy properly, the RMDs can be spread out and taken by multiple generations to provide a legacy income to your family while lessening the tax liabilities over time. A fixed indexed annuity works well with this strategy because it fully protects the principal from market volatility and provides contractual guarantees.
- Buy Life Insurance or Get in on the Annuity Action
If you quality for life insurance, you can determine what the after tax dollar amount would be from your RMD and then choose to apply that amount to purchase a policy. This is a great choice because the death benefit would pass tax-free to your noted beneficiaries. Term insurance is the most efficient and lowest cost choice available and would maximize the applied dollar amount.
However, if you don’t qualify for life insurance, purchasing a flexible premium fixed annuity with a guaranteed death benefit rider is another good option. Flexible premiums mean you can add money to the policy. This is an efficient way to use your RMDs, but note unlike life insurance policies, the death benefit DOES NOT pass tax-free to your beneficiaries.
Work with a Professional to Guarantee Results
The most important factors in minimizing RMD tax repercussions is to plan ahead (when possible) and to work with a professional who understands your unique financial scenario and can help you make the best decisions to protect your legacy funds.
Our mission at Gemlife Financial is to provide comprehensive wealth management strategies that allow our clients to accumulate, protect, and preserve their wealth.
Gemlife Financial is an independent firm, meaning our advice and recommendations come with no hidden agendas and no strings attached. Gemlife Financial does not offer proprietary products, which means we can offer the best products and services to our clients from a wide range of options.
We utilize a holistic approach to saving for retirement that incorporates financial planning, risk management, tax planning, and estate planning.