Age 70 1/2: Think Through Your RMD Choices
Buying a qualified longevity annuity and tactically timing the first RMD could reduce the tax hit.
In 2015, we are looking at planning ideas for different life stages. This month: The year the IRA owner reaches age 70 1/2.
The year the IRA owner reaches age 70 1/2 is his or her first "distribution year." It's the first year for which there is a required distribution. Unlike with later years, however, the IRA owner gets a one-time special break in the age 70 1/2 year: The minimum distribution for that year is not required to be taken until April 1 of the following year. In all other years for which there is a required minimum distribution, or RMD, it must be taken by Dec. 31 of the distribution year.
If the client's income is still "too high," and he or she doesn't want or need to take the RMD to pay living expenses, continue to look for ways to reduce the RMD, such as rolling into an employer plan if still working, Roth conversions, or purchasing a qualified longevity annuity (QLAC), discussed below. (This tactic could also be used in years prior to the age 70 1/2 year.)
Buy a QLAC?A longevity annuity is an annuity contract that does not start paying you until you reach age 85. It eventually pays you a life income, but the income does not start until that later age, meaning that your investment (if made when you are many years younger than 85) has many years to accumulate and grow, so the income you eventually get will be larger. The purpose is to insure against "living too long"--outliving your income.
Normally such delayed annuities are not "legal" investments for IRAs, because the minimum distribution rules require IRA-owned annuities to start paying out no later than age 70 1/2.
But the IRS has made an exception to permit IRAs to purchase "qualified" longevity annuities (QLACs) with up to $125,000 of the IRA balance, or 25% of the IRA owner's total IRA balance if less. When the QLAC is purchased, the purchase price and value of the QLAC cease to be counted as part of the IRA balance for purposes of computing the IRA's annual RMD, beginning the year after the year of the purchase.
Suki Example: Suki is turning age 70 1/2 and age 71 in 2015. She plans to keep working (and therefore expects to continue to be in a high tax bracket) for at least another five years. Her projections show she will have a comfortable income even after retirement, though if she lives to a very old age, it could become questionable. She finds a QLAC that will pay her a good income starting at age 85, in about 15 years. She buys it inside her IRA for $125,000. By removing $125,000 from her account value "base" in 2015, this move will reduce her next year's IRA RMD (i.e., 2016) by $4,883, saving her about $1,900 of income taxes that year. Equivalent savings will accrue each year thereafter until the QLAC starts paying out. If the contract makes sense for her, the tax savings is a nice little bonus. Of course her income (and taxes) will go up when she reaches age 85 and starts collecting on the QLAC, but she won't be working then (she figures), so she won't mind the taxable income as much.
You can also buy a QLAC in your IRA earlier or later than the year you reach age 70 1/2. The earlier you buy it, the longer your $125,000 investment has to accumulate and thus reduce your RMDs pre-age 85 by an even larger amount. The longer you wait to buy it, the less of a good deal it is and the less value it has for reducing RMDs.
Take the RMD This Year or Next Year?Since you have a choice, which is better? Take the age 70 1/2 year RMD in the age 70 1/2 year? Or postpone it until the age 71 1/2 year? Despite a magazine article that said "never postpone the first year's RMD!" this is actually something that needs to be decided on a case-by-case basis.
In a few cases, the choice will be easy.
Don't postpone the first year's RMD if…Someone who needs the age 70 1/2 year distribution to pay immediate living expenses will obviously not postpone. A person who is in a more or less steady income tax bracket, but whose RMDs are large enough that bunching two of them into one year would push him into a higher bracket in the age 71 1/2 year, should presumably not postpone. Postponement will not be possible if the participant desires to do a rollover or conversion from the plan in 2015: The RMD must be distributed before the account can distribute money for a rollover or conversion.
Do postpone the first year's RMD if… Someone is still working and earning a high income, but plans to retire later in the age 70 1/2 year, so expects to have a substantially lower income next year. Someone who is leaving his entire IRA to charity will probably postpone, since if he happens to die before taking the RMD that is just a little more money that will go the charity at his death income tax-free. Anyone who wants to maximize the amount of the IRA that will pass to her beneficiaries upon death should postpone taking the RMD as long as possible, in case he or she dies prior to the postponed distribution deadline.
The close cases…For others, the choice is not so easy. A client who expects to be in the same bracket next year as this year might decide based on personal preference: "Jack" takes his RMD early in his age 70 1/2 year, to "get it over with." His sister "Jill" postpones because, even though it looks like her bracket will be just as high next year as it is this year, you never know--she might get lucky and be really poor next year after all, making postponement profitable.
The person who thinks that postponing is always a good idea because you defer the taxes a little longer should remember that postponing actually increases the amount of the second year's RMD … because the age 70 1/2 year RMD that you did not take in the age 70 1/2 year is still part of the account balance at the end of the year!
One thing is sure: Postponing the RMD to the age 71 1/2 year creates complications. If the first year's RMD is postponed, two RMDs are required in the second year, and the two RMDs in the second year will have different deadlines, be based on different account balances, and use different divisors!
Bernie Example: Bernie turns age 70 1/2 in 2015, so 2015 is the first distribution year for his IRA. To calculate the 2015 RMD, he uses the 2014 year-end account balance and the Uniform Lifetime Table divisor for the age he attains on his 2015 birthday, which will be 70 if he was born before July 1, or 71 if he was born after June 30. He can take the 2015 RMD at any time from Jan. 1, 2015, through April 1, 2016. There will then beanother RMD for the year 2016, which must be taken between Jan. 1, 2016, and Dec. 31, 2016. The 2016 RMD will be based on the Dec. 31, 2015, account balance and will use the Uniform Lifetime Table factor applicable for the age he attains on his 2016 birthday.
Resources: See Natalie Choate's book Life and Death Planning for Retirement Benefits(7th ed. 2011) for full details on the required beginning date and the first distribution year. The book is available as a paperbound "real" book at http://www.ataxplan.com/ or in an electronic (online) edition by subscription athttp://www.retirementbenefitsplanning.com/.
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