If you’ve built up a large balance in tax-deferred accounts and have another source of income, such as a pension, RMDs can create a host of tax tribulations when you turn 70 1/2 and must start taking withdrawals. The key to avoiding a big tax bill is to start planning well before your 70th birthday.
Invest in a QLAC
Qualified longevity annuity contracts are deferred-income annuities that are a guaranteed source of income when you reach a certain age. For example, a 65-year-old man who invests $100,000 in New York Life’s Guaranteed Future Income Annuity and defers payouts for 15 years will receive $22,331 in guaranteed annual income, beginning when he turns 80. The catch? In this example, the annuity has no death benefit, so if the owner dies before age 80 he gets nothing. The same annuity with a death benefit that would pay heirs 100 percent of the premium not collected by the owner would cut the payout to $16,906 a year.
You can also use this type of annuity to reduce your RMDs. You’re allowed to invest up to 25 percent of your IRA or 401(k) plan (or $125,000, whichever is less) in a QLAC without having to take RMDs on that money when you turn 70½. You’ll still have to pay taxes when you start receiving payments from the annuity, but you can delay payouts until age 85.
Use your tax-deferred accounts for bonds and bond funds and use taxable accounts for stocks and stock funds, says Randy Bruns, a certified financial planner in Downers Grove, Ill. The advantage: Bonds and bond funds are taxed at your ordinary income rate; stocks and stock funds in a taxable account benefit from the capital-gains rate, which is 15 percent for most taxpayers.
Also, it’s likely that you’ll have fewer gains in bond-heavy retirement accounts. And because RMDs are based on the previous year-end value of your IRA, an IRA that grows more slowly will produce smaller RMDs.
There are limits to this strategy. If most of your retirement savings is invested in traditional IRAs and 401(k)s, you should include stocks and stock funds in those accounts. Otherwise, you’ll sacrifice long-term growth and have more trouble beating inflation.
As baby boomers reach retirement age, a growing number are planning to work past age 70. As long as you’re still working, you don’t have to take RMDs from your employer’s 401(k), even if you’re older than 70 1/2. You’ll still have to take RMDs when you quit. But you’ll reduce or eliminate mandatory withdrawals while you’re working, when your tax rate could be much higher.
Article created by The Chicago Tribune.