I started to focus on retirement income planning about 15 years ago. One thing that struck me early in this journey was just how much our clients detest required minimum distributions (RMDs).
A large percentage of our clients were federal retirees with large pensions under the old system. They didn’t need the money.
It wasn’t that they were mad about having to take the funds — it was the taxes. On top of the taxes, there were also the other dominos that could fall — the phaseout of certain deductions, higher capital gains taxes and, perhaps the most hated, Medicare premium hikes (IRMAA).
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Today, many of our clients still hate RMDs. This is not just because they all have large pensions, but many have put themselves in strong financial positions and do not like paying taxes on money they don’t need. It’s like paying the tolls on the Jersey Turnpike but having no desire to actually get where you’re going.
We use many strategies to lower our clients’ lifetime tax bills, but these three very niche strategies are designed to stop or delay the actual income you don’t want, in turn, reducing or deferring the taxes.
1. Skip your first RMD
Everyone is eligible to defer the RMD in the year they hit their RMD age. This can be 70½, 72, 73 or 75, depending on your year of birth. This sounds better than it is, but it can make sense in the right situation.
Let’s say you were born in 1960. Your RMD age is 75, and you will hit that in 2035. You can defer your 2035 RMD until 2036. Here’s the catch: You’ll then have to take two RMDs in 2036, one by April 1 and one by December 31.
Doing this without running the numbers can really backfire, because that lumpy distribution is more likely to cause more bad dominos to fall than if you’d split the distribution over two years.
Here are some situations where we’ve seen it make sense to skip the first RMD:
- You retire in 2035 and will have a significant income drop in 2036
- You sell your business in 2035
You have a lump sum from any other source in 2035 that causes your income to spike (unpaid leave, inheritance, inherited IRA distribution, home sale, etc.)
You see the theme. If your income is much higher in 2035 than you expect it to be in 2036, it could be beneficial to skip your first RMD. We rely on financial planning software to project out tax rates to make that determination. You can access a version of what we use.
2. Buy a qualified longevity annuity contract, or QLAC
When interest rates were hovering around zero, it rarely made sense to turn to a QLAC. Income guarantees move in the same direction as interest rates, so if there is any silver lining to inflation, it’s that most fixed annuity rates moved up as the Fed raised rates to combat inflation. Merry Christmas!
A QLAC is a type of deferred annuity, basically meaning you give money to an insurance company in exchange for a future income stream. This is a unlike a single premium immediate annuity (SPIA), with which payments start immediately.
I believe that you need to approach this as longevity insurance first and as a tax tool second. Because many of these contracts will defer income until age 85, you are making a big bet on longevity.
The tax benefit is that you can move up to $210,000 per person (2026 limit) from your IRA into a QLAC. Round numbers: If RMDs start at 4%, you are delaying just $8,400 per year in RMDs.
“Delaying” is the key word. When that money does come out, it is still taxable.
Once again, this makes sense if you are already considering an annuity as a longevity hedge and like the idea of guaranteed income later in retirement.
3. Keep working
This one is not complicated but is often misunderstood. A costly mistake. If you are still working in any capacity as an employee and own less than 5% of the company, you can defer RMDs from your current employer retirement plan, but not from all your retirement plans.
Take the example of the client who started a manufacturing business that he sold to his employees. The business is his life. He tells me he’ll work until the day he dies. I tell him he’ll work until the day the new owners decide they can’t take him anymore. He sort of laughs. He can defer RMDs until that day.
More commonly, we see clients continuing to work part-time in retirement. For anyone who is still working, and for employer retirement plans that accept rollovers into the plan, you may be able to roll funds from your IRA into your current employer plan and avoid RMDs on a much larger chunk of money.
This is the definition of the tax tail wagging the investment dog, which most textbooks caution against. But if you’ve got a good retirement plan at work and don’t plan to stop working, it may make sense.
Most retirees spend more than their RMDs every year, so this is really an uptown issue for those who are really focused on taxes, as we are in our practice.
It is important to note that there are very few ways to completely eliminate the tax consequences, as you would if you did a qualified charitable distribution (QCD), so it’s important to note that there is no prize for being the best tax deferrer. It only makes sense if your future tax rates will drop.