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By Christine Benz | 07-20-2017 11:00 AM

Options for Easing the Pain of RMDs

IRA expert Ed Slott shares a few workarounds for retirees who want to reduce their tax burden or the amount of their required minimum distributions.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Many retirees love to hate their required minimum distributions, which they have to take from their IRAs once they hit age 70 1/2. Joining me to discuss what, if anything, retirees can do to lower their RMDs is IRA expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Great to be here. Thanks.

Benz: I always think if I'm talking to a group of retirees there are a couple of topics that get them fired up--one is long-term care, the other is required minimum distributions.

Slott: I know.

Benz: Retirees love to hate their RMDs. Let's just start by talking about what required minimum distributions are and at what life stage they apply.

Slott: Basically, required minimum distributions is the government's way of saying, we're sick and tired of waiting for you to drop dead and we want our money back. We gave you this deal; you got your tax deductions; now, it's payback time. And they have a name for that date. It's called required beginning date. That's basically your 70 1/2 age, which I think most people know, where money has to start moving the other way. You've been going, building, saving, and investing, and accumulating. Now, it's got to come out. Not a lot, but little pieces and it has to, even if you don't want the money to come out, you're forced to take it, because if you don't take it, it's a 50% penalty on the amount you didn't take but should have.

Benz: A huge penalty. So, these RMDs apply to traditional tax-deferred accounts; that would be, IRAs, company retirement plan assets, as well as actually Roth 401(k)s …

Slott: Oh, a good one. Roth 401(k)s, but not Roth IRAs. That's the big difference.

Benz: Right. OK. You have written about and talked about some potential workarounds for people who want to try to reduce their required minimum distributions. Let's talk about some of them. One of them is the qualified charitable distribution. I know a lot of retirees really like this strategy. But let's talk about it and why it can be beneficial.

Slott: It's not used enough. It can reduce the tax impact. Remember, that's the number-one complaint against required minimum distributions. People say, I have to take money, I don't want to take, I don't need. I have to pay tax on it. It increases my income, which decreases all kinds of tax benefits, exemptions, deductions, credits that are based on levels of income. Is there a way--I know I have to take the required minimum distributions--is there a way I could lessen the tax impact? Qualified charitable distributions, it's a provision that was put in law over 10 years ago, but it was in and out and repealed and put back. Now, it's permanent. Whatever that means in …

Benz: As of end of 2015.

Slott: Right. So, it's a way if you're giving to charity anyway--and I'm not saying give more to charity to get a tax deduction because if that's the way you think, sure, if you gave $1 million to charity, you'd have a lower tax bill and you'd be broke. But I'm saying, the amount you're giving anyway, if you're 70 1/2 or older--doesn't apply to everyone, you have to be an IRA owner or an IRA beneficiary who is 70 1/2 years old or older. It doesn't apply to distributions from company plans and it doesn't apply to donor-advised funds or private grant-making foundations.

It has to be a direct transfer from your IRA to the charity. And you can do up to $100,000 a year. Now, that's more than most people need. But let's say your RMD is $5,000 and you also, just to make the example easy, give $5,000 a year. I'm not telling you to give more. You're already doing that. If you did a direct transfer, that's what the qualified charitable distribution is, it's a direct transfer from your IRA to the qualifying charity, you don't have to include that $5,000 in income. It's excluded, but it satisfies your RMD. So, now, your income is lower. You don't to have to add the income from your RMD to your tax bill.

Benz: I could theoretically do this with more than one charity, too, right? I don't have to just pick one? And then this is--the $100,000 is on an individual basis. So, if you've got a couple who are very charitably inclined and wealthy, they could potentially do even more than $100,000 assuming that they each had their own IRAs?

Slott: That will lower the tax impact on the RMDs. It won't lower the RMD because you'll still have taken it, but it would have been satisfied by the transfer to the charity.

Benz: Let's talk about another strategy. This is a little bit more arcane, but I think nonetheless worth talking about, qualified longevity annuity contract, sometimes called QLACs in the business. Let's talk about who might take a look at this strategy as a means of potentially lowering their RMDs.

Slott: It's kind of a new strategy, not well-known. It's a way to have longevity annuities. The idea there is, most people are going to live past age 85. It's just the longevity issue, and they don't want to run out of money. When you take your RMDs, they get higher and higher as life expectancy diminishes, and people don't want to run out of money. So, this is an annuity that kicks in, that's why they call it a longevity annuity, somewhere around 85, and it kicks in so you have income for life. But the beauty of it is to lessen the impact of your RMD, the amount you set aside, up to a limit of $125,000 or 25%, whichever is less, up to that limit is excluded from the balance you use to calculate your RMD, which means your RMDs are only based on the other assets which will lower the tax bill.

Benz: This can make sense if you both want to lower your RMDs and you are concerned about potentially outliving your assets and think about one of those longevity annuities ...

Slott: It's a great benefit.

Benz: Let's talk about another one. This is probably limited to a smaller subset of retirees. But for people who are still working post age 70 1/2, they may have an option to roll in some of their IRA assets into their company retirement plans. Let's talk about how that would work.

Slott: That's something called the still working exception. And as you said, it doesn't apply to everybody. But if you're working for a company and they have a 401(k) and you are over 70 1/2, you can delay required distributions until you retire if the plan allows this. They don't have to.

What some people do is, they say, well, I have this IRA. Now, the still working exception, or a waiver of the RMD rules, only applies to the 401(k) of the company you're still working for, not for other 401(k)s you have and not to IRAs. So, if you have IRAs on the side, they are still subject to the required minimum distribution rules. So, some people say, well, if I could roll that IRA, if the company lets me, back to the plan then I could eliminate the RMDs of my IRAs till I retire. You're just putting it off till--hopefully, the theory is, you'll be in a lower tax bracket in retirement, and you're just putting off the problem to a later time.

But you have to, first, be still working, you have to have a company plan, they have to allow roll-ins, and they have to have the still working provision. But if you're doing that, you still have to be careful. If you're already over 70 1/2 and subject to required minimum distributions on that IRA, you first have to take your RMD for that year. Once that's satisfied, you can roll the balance in, if all of those factors are present that I just said, and yes, you could delay it. So, that would lower the tax bill for RMDs while you're still working.

Benz: These are all strategies for people who are post age 70 1/2. Let's talk about one that people can think about pre-70 1/2, but maybe post-retirement would be a particularly opportune time. This is considering some sort of conversion from those traditional tax-deferred assets to Roth. Let's talk about how, that can obviously work to lower your balance, and who should consider that strategy.

Slott: If you're doing a Roth conversion, it means you're paying tax now. But once the money is in the Roth, there are no required minimum distributions during your lifetime. So, that's a big benefit. So, come 70 1/2, you can just keep accumulating in the Roth and there's no requirement to take money out, but you have to pay for that privilege. So, what some people do, as you said, before 70 1/2, and this is where you have to look down the road, if you want to reduce your required minimum distributions at 70 1/2, maybe 10 years earlier, you do a series of partial Roth conversions, and over time you start transferring your IRA money or some portion or maybe all of it--you check with your advisor to see what's best for you and your tax bracket--or maybe part of it or all of it over time so that when 70 1/2 comes around, you may not have any IRA. It my all be in the Roth or a part. Either way, it might be lowered or eliminated, those RMDs.

Benz: One question I have for you is, we've had this great rally in the stock market. People's balances are enlarged and your RMDs get calculated off of whatever your balance was at the end of the previous year. How are you thinking about conversions given that, given that people's balances are arguably on the high side certainly relative to what they've been?

Slott: Well, who cares anyway. You know why? Because with Roth IRAs you get to undo it. It's one of the greatest provisions in the tax code. So, even if you don't know and you're converting at a high balance, and that's a good concern because it means your tax bill will be higher. If you convert and you are worried about the tax bill--if you convert, say, now, we're in 2017, you have until October 15, 2018, to undo that Roth conversion, eliminate the tax bill, part of it or all of it, well after the year is over and you really know where you stand. I always say it's kind of like getting a bet on a horse after the race is over. That's why I say, you're not taking any risk. That's why I said, who cares. Of course, I care, but there is no risk there because it can be undone. Now, if you think tax rates may go a little lower, that's a concern. Maybe you hold off on it. But there is really no risk at jumping in, especially if you feel that there's even more appreciation ahead.

Benz: Right. And then I guess the idea is, if the market takes a tumble and your accounts take a tumble, you can undo it and go back and maybe do it at a later date.

Slott: Yeah.

Benz: OK. Ed, important set of considerations here, required minimum distributions. Great to hear your thoughts on this topic. Thank you for being here.

Slott: Thanks.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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