How Career Extenders and Sandwich Caregivers can manage RMDs

Making the most of retirement income for aging population

Individual Retirement Accounts (IRAs) can be valuable products for boosting retirement savings. The Internal Revenue Service (IRS) allows tax deferral on contributions to traditional IRAs, which is a powerful incentive to save, invest and grow income for later in life. But there comes a time when the tax bill is due. Current regulations require investors to start taking money out of tax-deferred accounts like traditional IRAs no later than April 1 following the year they reach age 72. Most employer sponsored plans like 401(k) accounts require distributions no later than April 1 following the year a person leaves employment or age 72— whichever is later. Distributions must continue by December 31 of each year that follows, for the life of the account owner. This money taken out — called Required Minimum Distributions (RMD) — is taxable as income, and available for retirees to spend.  If a person didn’t take their required minimum distribution, there’s a steep penalty — 50% of the amount of the RMD not taken — so ignoring this rule isn’t a good option.

How to minimize or reinvest if you don’t need to spend RMDs

Despite these regulations, many retirees and workers age 72 and above would prefer not to take RMDs at all or would like to keep their distributions to a minimum. Those who are career extenders working later in life may have sufficient employment income to meet their needs, so they’d rather keep their savings growing. They may also be in higher tax brackets due to income from both salaries and pensions, rental income and other investments. This makes RMDs even less attractive, as the tax bill grows. 
For those working a second or third career, there could be an opportunity to use their new employer-sponsored retirement plan to defer RMDs. Unlike IRAs, employer plans like 401(k)s from a current employer do not require most employees to take minimum distributions while they are working at that job. Employees who are age 72 or older might be able to rollover* their IRAs and 401(k)s from previous employers into their current employer’s plan to defer their distributions until they decide to retire. 
Individuals who are 72 years old or older also may take advantage of the following strategies to reduce their required distributions.

Many of these specific planning steps can start years before retirement and help to reduce the balances subject to RMDs, including but not limited to: 

• Roth conversions — Part or all of a person’s pre-tax IRA can be converted to Roth IRAs, which are after-tax and require no RMDs. This conversion is a federally taxable event at the time and is irreversible, but upfront payment of these taxes could be beneficial, in the long run. Tax and financial professionals should be consulted before implementing a Roth conversion strategy.
• Qualified Longevity Annuity Contract QLAC — Part of a person’s retirement account (25% or $135k whichever is less, subject to cost of living adjustments) can be used to purchase an annuity that provides income later in life. This amount is removed from the IRA balance, and therefore reduces the amount of the RMDs required. Distributions from the annuity can be deferred until as late as age 85.
• Qualified Charitable Distributions QCD — the IRS allows up to $100,000** per year to be donated directly from IRAs to approved charitable causes. Using an RMD for these donations could potentially satisfy the RMD requirement without affecting the donor’s taxable income. Essentially, taxpayers might get a full tax deduction for RMDs donated directly to charity.  

How to leverage RMDs to help pay for care:

Some investors might need additional predictable income after age 72 to help pay for their own long-term care needs.  Those caring for others may need an income source that can help offset caregiving costs or be used to purchase long-term care and/or life insurance protection for their loved ones. RMDs can be paid out systematically on a monthly or annual basis and can be an easy way to spend qualified assets without depleting retirement accounts too quickly.

Considering long-term care insurance, life insurance, or hybrid policies that can cover both needs could be part of an overall strategy that makes the most of family resources and the protection available. For older Americans who are healthy enough to purchase insurance, RMDs can help fund policies that can pay for future care needs or build a legacy. By using RMDs to pay insurance premiums, IRA owners can use unwanted income to provide some peace of mind for themselves and their family. 

RMDs from inherited accounts:

RMDs don’t only affect taxpayers during their lifetimes, they can have a big impact on the lives of their heirs, as well. When IRA or employer sponsored plan owners name beneficiaries, they are passing on not only their remaining savings in their retirement plan to them, but also the future taxes due on that savings. Most individual beneficiaries are required to withdraw their full inherited IRA or employer sponsored plan balances from the account within 10 years after the death of the account owner, due to recent regulations. But others — like minors, people with disabilities, special needs trusts and people with chronic illnesses — may be able to “stretch” their inherited IRAs by taking RMDs typically over their life expectancy. These RMDs create cash flow that can help pay for care, but the income created by the RMDs also could impact government benefits eligibility and taxation. Because RMD rules can be highly complex this article is a high-level summary. Careful planning with specialist financial and legal professionals is important for IRA and employer sponsored plan owners or beneficiaries who have disabilities or chronic illnesses. 

For many investors, RMDs are an unplanned-for tax burden. But, by understanding some of the available strategies to reduce or delay distributions, individuals working with tax professionals can minimize their impact. For those paying for their own care or who are caring for loved ones, with proper planning, RMDs could be seen as an opportunity to leverage retirement assets and provide for a better quality of life.