When it comes to retirement plan distributions, IRS rules require everyone with a retirement account to take required minimum distributions (RMDs) once they reach age 72 (formerly age 70 1/2 until Dec. 31. 2019). However, not everyone who reaches that age needs the money. For those individuals, the question is: what to do next?
Since IRA distributions are usually taxable immediately, the question of what to do with the money is often entwined with a desire to find tax-efficient strategies. Here are five strategies to help high-net-worth individuals (HNWIs) navigate RMDs and protect their financial legacy.
1. Donate to charity
Charitable donations are high on the list of priorities for Americans at this time of year, and the IRS helps make that easier.
"By making a qualified charitable donation, you can give $100,000 a year directly from the IRA to charity," says Dean Deutz, a private wealth consultant at RBC Wealth Management-U.S. The IRS says that counts toward the RMD.
Both spouses can donate from their IRAs, but the $100,000 distribution allowance isn't shared if you're filing a joint return. In simple terms, if one spouse donates $75,000, the other is still able to donate $100,000.
2. Move to a Roth IRA
Another option to consider is converting a regular IRA into a Roth IRA. Traditional IRAs are funded with pretax dollars, while after-tax dollars are used to fund Roth IRAs. Payouts and capital growth from Roth IRA plans are tax-free and can be inherited free of inheritance tax. There are also no RMDs for Roth IRAs.
"Roth conversions are a key thing to do," says Deutz. The conversion will involve some payment of income taxes on the holdings of the IRA when it is converted to a Roth, but this technique has some flexibility. The conversion doesn't have to involve all of the assets in a regular IRA account, which means it should be possible to manage the conversion process to maximize tax efficiency. This can be particularly useful if your tax rate is likely to increase in the future.
3. 529 college savings plans
Alternatively, you can use the cash from an RMD to help fund a 529 college savings plan, although that may not help much when it comes to federal taxes, now or later. That's because the annual contributions to 529s are limited to $15,000 a year and are not deductible for federal tax purposes, though there may be deductions at the state level. Earnings on these plans grow tax-free as long as the distributions get used for qualified expenses, including tuition.
4. Consider a qualified longevity annuity contract
One enduring maxim about tax management is to defer the payments as long as possible. The Qualified Longevity Annuity Contract (QLAC) helps individuals do just that. QLACs provide guaranteed monthly payments until death, and as long as the annuity complies with the Internal Revenue Service (IRS), you can defer RMDs until age 85.
"A QLAC allows you to defer your RMDs when you do not need the income," says Carol Goetsch, senior product manager, annuities and insurance, at RBC Wealth Management-U.S.
With a QLAC, you exchange some of your assets for a lifetime stream of money. No matter how long you live, you'll keep getting payments. The money doesn't grow, but it can't go down.
Besides guaranteed lifetime income, QLACs have the added benefit of reducing a person's required minimum distributions, which IRAs and qualified retirement plans are still subject to even if an individual does not need the money, Goetsch explains. This can help keep a retiree in a lower tax bracket, which has the added benefit of helping them avoid a higher Medicare premium.
The IRS limits the total contribution to 25 percent of the assets in the IRA, up to a maximum of $130,000.
5. Purchase a variable annuity
Individuals who are confident they won't need money from their IRA might consider using cash from an RMD to buy a variable annuity with a death benefit.
"A variable annuity is similar in concept to a mutual fund, in that finance professionals manage the funds and the value of the investment can go up and down," says Goetsch. "But the variable annuity can have a death benefit rider which guarantees that the beneficiaries will get at least the amount invested."
For as long as you live, the assets in a variable annuity can grow tax free. Upon death, the beneficiaries will get at least the same amount of money you put into the annuity. If the assets grow, then they may receive more. Once the IRA is passed on, regular IRS rules would then kick in when distributions are withdrawn. The annual costs are typically around 2-2.5 percent of the total amount invested.
There are several options available for HNWIs who may not need the money from their RMDs, and no one-size-fits-all approach. Discuss your personal situation with your financial advisor to decide which might best help you stay on track with your wealth plan during your retirement years.
RBC Wealth Management does not provide tax or legal advice. We can work with your independent tax/legal advisor to help create a plan tailored to your specific needs.
All annuity guarantees, including optional benefits, are backed by the claims-paying ability of the issuing company and do not apply to the underlying investment options.