“Although I am over 70, I am still working. My company’s CPA just told me that this
year I will have to take money out of both my company 401-k plan and my personal
IRA. I don’t want to do that since it will increase my income tax liability. Is she right?
She could be right; however, even if she is, there are ways that you can minimize your tax pain.
By way of background, one of the main benefits of contributing money to company 401-k plans and personal IRAs is the ability to get capital appreciation in tax-deferred accounts. In order to receive tax-deferred capital appreciation, the IRS demands that you begin liquidating traditional 401-ks and IRAs by April 1 of the year following the year that you turn age 70½. The amount of money that must be distributed from these accounts is called a “Required Minimum Distribution” or RMD.
The good news is that there is a big exception to the RMD rules for 401-ks that are sponsored by the company you currently work for. That is, taxpayers are not required to take an RMD if they
own 5% or less of the company they currently work for. This special rule does not apply to 401-k plans that you might have left behind at former employers.
As far as your personal IRA, there are three ways that you can minimize your RMDs:
- Qualified Charitable Distribution (QCD). Taxpayers who are 70½ years old or older can make distributions directly from IRAs to qualified charities. For example, if you give money to your church or some other non-profit organization, you can use the QCD instead of using other savings. The amount of the QCD (up to $100,000 per year) will not be taxed to you. In addition, the QCD counts toward fulfilling your Required Minimum Distribution.
- Qualified Longevity Annuity Contract (QLAC). A QLAC is a type of annuity that pays a guaranteed monthly income sometime in the future in exchange for a lumpsum deposit today. You can deposit up to 25% of your retirement balance up to a maximum of $125,000 per taxpayer. Let’s look at an example. Suppose that you have $500,000 in your IRA and you deposit $125,000 into a QLAC. Your taxable RMD will now be calculated on $375,000 instead of $500,000, which should save you current income taxes.
- Roth IRA Conversions. Taxpayers can convert some or all of their taxable IRA accounts into tax-free Roth IRA accounts. When they do, they must pay income taxes on the conversions. However, since Roth IRAs are not subject to RMDs, the eventual tax savings can be significant.
At Goepper Burkhardt we help our clients minimize their RMDs. It’s important to note that Qualified Charitable Distributions, Qualified Longevity Annuity Contracts and Roth IRA Conversions are complicated and require a significant amount of explanation before they are implemented.