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Ask the Retirement Expert: If I Don’t Need the Money From an RMD, What Should I Do?

Amy Jamrog, CLU®, ChFC®, CASL® •  February 19, 2016 | Enjoying Retirement, Your Finances, Ask the Expert

Each week our Northwestern Mutual retirement experts answer your questions. This week’s question:

If I don’t need the money from an RMD, what should I do?

By Amy Jamrog, CLU® ChFC® CASL®

Amy has been a Wealth Management Advisor with Northwestern Mutual since 1999. She has achieved company, industry and community recognition since her first year in business. Over the past 16 years, she and her team have developed a specialty in helping baby boomers with retirement income planning.

The IRS mandates you withdraw money from most retirement accounts—like IRAs or 401(k)s—after you turn 70½ years old—this is called a Required Minimum Distribution (RMD). Since that money has been growing tax deferred for all these years, the IRS is very interested in finally collecting tax dollars on your distributions.

The amount of your RMD is based on a percentage of the balance in all accounts subject to RMDs at the end of the year before you turn 70½. Your RMD is approximately 3.64 percent of the total value of your accounts the first year and increases as you get older. Assuming your money grows each year, then the amount you are required to withdraw every year increases as well. This is taxable income.

If you are in the enviable position of not needing this money at the time you are required to take a distribution, what can you do? Here are five strategies to consider:

For some people, the RMD puts them into a higher tax bracket—which no one is interested in. So what do you do? Well, if you are already 70½, you can take up to $100k of your IRA and transfer it directly to a charity without having to incur any taxable income. 

If you’re younger than 70½, now is the time to start doing some proactive RMD planning. For example, you could take distributions without penalty beginning at age 59½ to reduce the amount you will have to take each year once you reach 70½ and therefore reduce your long-term tax exposure at age 70½.

If you have no intention of using money in a retirement account and want to pass it to the next generation, you might consider life insurance. For example, I had a client several years ago who didn’t want or need his RMD money, which was approximately $50,000 each year. However, he was very interested in doing something more meaningful with the money for his grandchildren. He used the $50,000 annual RMD to buy a $1 million permanent life insurance policy on himself. He pays the $50,000 premium every year and will spend down his retirement account in his lifetime. Here’s the benefit: Instead of leaving his children and grandchildren an IRA that would be taxable to them at his death, he instead will leave behind a $1 million life insurance policy that has no ordinary income tax assessed to it. By doing this he is multiplying the gift to his family.

Another option you could consider is a type of annuity known as a Qualified Longevity Annuity Contract (QLAC). The government allows you to direct up to $125,000 of your IRA money—or 25 percent of your total IRA account values, whichever is less—to  a QLAC and defer having to take any required minimum distributions (RMDs) on that money until you reach age 85. For high-net-worth individuals, this can be a very savvy strategy.

If you want to eliminate the RMD issue altogether, consider converting your pretax IRA to a Roth IRA. You will have to pay the tax on this conversion now, but it can potentially save you more in taxes later. This is a strategy you should definitely talk with your accountant about, but it can really benefit you and your beneficiaries later. And even better: Your Roth IRAs have no Required Minimum Distribution because the dollars have already been taxed.

Of course, it’s best to discuss any of these ideas with your financial professional and accountant first. Everyone’s situation is different, and a great strategy for one person might not work as well for another.

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