RMDs: What You Need to Know and How to Minimize Their Impact

As you approach retirement, it’s essential to understand how required minimum distributions (RMDs) can influence your financial landscape. Recent changes in legislation have adjusted the age for mandatory RMDs from retirement accounts like 401(k)s and IRAs to 73, with plans to raise it to 75 by 2033.

To illustrate, if you’re 73 with a $2 million balance in your 401(k), the IRS’s life expectancy table for 2024 indicates a factor of 26.5. This means your RMD for the year would be over $75,400. If you’re in the 35% tax bracket, you’d be looking at a tax bill of $26,390.

However, if you don’t need these funds immediately and prefer to maximize their growth or leave them as an inheritance, there are strategies to consider:

#1 Qualified Longevity Annuity Contracts (QLACs)

  • What are they? These are annuities offered by insurance companies exclusively for retirement plan participants.
  • Benefits:
    • Transfer up to $200,000 from your retirement assets to a QLAC between ages 73 and 85 without immediate tax implications.
    • This reduces your RMDs, leading to a lower tax bill.
    • QLACs provide a guaranteed income stream for life. You can start receiving this income before turning 85. While this income is taxable, you might be in a lower tax bracket by the time you start withdrawals.
    • You can set up a death benefit for your heirs, giving them the option of periodic payments or a lump sum. However, they must liquidate these assets within a decade of acquisition.
    • Drawback: Once you move assets to a QLAC, they’re locked in until the income distributions start.

#2 Roth IRAs

  • What are they? A type of retirement account where you pay taxes upfront but enjoy tax-free growth and withdrawals.
  • Benefits:
    • Convert your traditional IRA or 401(k) to a Roth IRA, pay taxes now, and avoid future taxes on growth and withdrawals.
    • Roth IRAs aren’t subject to RMDs, allowing your assets to grow tax-free.
    • Withdraw funds tax-free for emergencies.
    • Leave a tax-free inheritance for your heirs. Beneficiary rules vary: children must liquidate the inherited Roth IRA within ten years, while spouses have more flexibility.
    • Drawback: Converting to a Roth IRA might result in a significant immediate tax bill.

Which Option Is Best for You?

While QLACs can reduce your RMDs, they won’t eliminate them. They offer tax deferral until you start receiving the guaranteed income, which will then be taxable. On the other hand, Roth IRAs provide tax-free growth and withdrawals but require an upfront tax payment upon conversion.

A Roth IRA might be more suitable if you value flexibility and want to leave a tax-free inheritance. However, with QLACs, you only need to transfer up to $200,000, leaving the rest of your assets accessible, though taxable.

Remember, your financial decisions should align with your retirement goals and needs. Seeking advice from a financial advisor can offer you customized guidance for your financial goals.