Here is my question, which uses hypothetical values for simplicity: My RMD for 2024 is $10,000. Can I avoid paying the IRS the tax on that $10,000 this year by investing the full $10,000 RMD or the value of the tax on the $10,000 into a qualified longevity annuity contract (QLAC). I just retired in 2024 so my tax load on my earned wages is already large enough which is why I would like to invest the full value of the RMD into a QLAC.
– Paul
Thanks for your question, Paul. Unfortunately you cannot. Although a qualified longevity annuity contract (QLAC) can indeed help you reduce the size of your RMDs, you wouldn't be able to use it exactly the way you've described. On the other hand, a qualified charitable distribution (QCD) would allow you to avoid the tax on your current RMD. Whether that’s a good strategy for you depends on if you normally give to charity, as well as your intended use of the money.
A financial advisor can help you plan for RMDs and manage your streams of income in retirement. Connect with a fiduciary advisor today.
Required Minimum Distributions (RMDs)
The issue lies not with QLACs but with the rules governing RMDs – the annual withdrawals that must be made from tax-deferred accounts like traditional IRAs and 401(k)s starting at age 73 (75 for people born in 1960 or later). As a result, it helps to review how RMDs are calculated.
Your annual RMD is determined by dividing your account balance by the distribution period that corresponds with your age, as outlined in the appropriate IRS table.
The account balance used in this calculation is the value as of December 31 of the previous year. For example, your 2024 RMD is based on your account's closing balance on Dec. 31, 2023, while your 2025 RMD will be based on your account’s closing balance on Dec. 31, 2024.
While these distributions are required every year, you can delay your first RMD until April 1 of the year after you reach RMD age. For example, if you turned 73 in 2024, you would have until April 1, 2025, to take your first distribution. However, delaying your first RMD until April means you’re still required to take your second RMD by the end of that same year.
It's also important to note that you cannot “reinvest” your RMD into another IRA or convert it to a Roth IRA. The funds must be withdrawn, and you may owe taxes on the distribution. (And if you need additional help calculating and managing your RMD, consider speaking with a financial advisor.)
How Would a QLAC Come into Play?
QLACs allow you to purchase a life annuity within your tax-deferred account without having to worry about the need to immediately take RMDs from the amount you use to pay for the premium. That amount is simply taken out of the equation. That makes sense given that once you purchase the annuity, that money wouldn't be available to withdraw.
QLACS exist to give you the opportunity to to buy income annuities in your tax-deferred accounts and delay the start of your monthly payments until you turn 85.
For example, suppose you have a $500,000 IRA at the end of 2024, and your distribution period is 26.5 years according to the Uniform Life Table. Dividing $500,000 by 22 would give you an RMD of $22,727 for 2025.
In order to use a QLAC to reduce that amount, you would have needed to purchase it in 2024. That is so the amount would be excluded from the calculation. Suppose you had paid $100,000 for a QLAC before the end of 2024. Your RMD would have been based on the remaining $400,000 in the account. Dividing $400,000 by 26.5 would give you an RMD of $15,094 for 2024.
Without using the $100,000 to buy a QLAC, your RMD would be based on a $500,000 account balance. As a result you would have to withdraw nearly $19,000 from your account to satisfy the RMD. In other words, a QLAC reduces your RMD on the front end. The question you present is about reducing it on the back end.
(If you have additional questions about QLACs or other types of annuities, connect with a financial advisor and see if these products could be right for you.)
Qualified Charitable Distribution
A qualified charitable distribution (QCD), however, is something you can use to directly reduce your current year RMD. With a QCD, you simply distribute the RMD directly to a qualified charity. This is not the same as taking a deduction for a charitable gift.
Charitable deductions are limited to a percentage of your AGI. You can only take a charitable deduction if you itemize.
With a QCD, the distribution isn’t added to your income, so you forgo the income tax you would otherwise pay on your RMD. Also, whether or not you itemize or take the standard deduction does not affect your ability to use a QCD.
Of course, the rub here is that you have to give the money to a charitable organization. While that is a great thing to do, the reality is you may not have intended to and may need that money yourself. QCDs make the most sense for people who regularly give to charity. (And if you need help making a QCD or your tax strategies for giving to charity, consider working with a financial advisor.)
Bottom Line
Like Roth conversions, QLACs reduce the tax-deferred account balance that future RMDs will be based on. However, if you haven’t already purchased one, buying one now won’t impact your RMD this year. That’s because RMDs are calculated using your account balance from the end of the previous year. On the other hand, a QCD may help you reduce your current-year RMD, but it doesn't leave you with more money in your pocket compared to taking the RMD.
These outcomes may not be what you had hoped. They also shouldn't be surprising when you think about the reason RMDs exist in the first place – to prevent perpetual tax-deferral. RMDs are designed to be hard to avoid.
Tips for Managing Your RMDs
- Treat RMDs as part of your overall cash flow strategy. You can use the withdrawals to cover living expenses, reinvest in taxable accounts or even gift to family members. Aligning RMDs with your financial goals ensures the distributions are used effectively while minimizing tax implications. And if you need help calculating your RMD, SmartAsset’s RMD calculator can give you an estimate.
- Some financial advisors specialize in retirement planning, helping clients plan for and manage their RMDs. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you'd like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.
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