We use many strategies to lower our clients’ lifetime tax bills, but that’s not what this column is about. It explains three very niche strategies to stop or delay the actual income source, in turn, reducing or deferring taxes.
1. First-year deferral
Everyone is eligible to defer the RMD in the year they hit their RMD age. This can be 70.5, 72, 73 or 75, depending on your year of birth. This sounds better than it is but can make sense in the right situation.
Let’s say you were born in 1960. Your RMD age is 75, and you will hit that in 2035. You can defer your 2035 RMD until 2036. Here’s the catch: You have to take two RMDs in 2036. One by April 1 and one by December 31. Doing this without running the numbers can really backfire because that lumpy distribution is more likely to cause more bad dominos to fall than if you split the distribution over two years.
Here are some situations where we’ve seen this make sense:
- You retire in 2035 and will have a significant income drop in 2036.
- You sold your business in 2035.
- You had a lump-sum from any other source in 2035 that causes your income to spike (unpaid leave, inheritance, inherited IRA distribution, home sale, etc.).
You see the theme. If your income is much higher in 2035 than you expect it to be in 2036, this could make sense. We rely on financial planning software to project out tax rates to make that determination.
2. OLAC – Qualified Longevity Annuity Contract
Income guarantees move in the same direction as interest rates, so if there is any silver lining to inflation, it’s that most fixed annuity rates moved up as the Fed raised rates to combat inflation. Merry Christmas!
A QLAC is a type of deferred annuity, basically meaning you give money to an insurance company in exchange for a future income stream. This is unlike a single premium immediate annuity (SPIA), which starts immediately.
I believe that you need to approach this as longevity insurance first and as a tax tool second. Because many of these contracts will defer income until age 85, you are making a big bet on longevity. The tax benefit is that you can move up to $210,000 per person (2026 limit) from your IRA into a QLAC. Round numbers: If RMDs start at 4%, you are delaying just over $8,000 per year in RMDs. Delaying is the key word. When that money does come out, it is still taxable. Once again, this makes sense if you are already considering an annuity as a longevity hedge and like the idea of guaranteed income later in retirement.*
3. Keep Working
This one is not complicated but is often misunderstood. A costly mistake. If you are still working in any capacity as an employee and own less than 5% of the company, you can defer RMDs from your current employer retirement plan, but not from all your retirement plans.
Take the example of the client who started a manufacturing business that he sold to his employees. The business is his life. He tells me he’ll work until the day he dies. I tell him he’ll work until the day the new owners decide they can’t take him anymore. He sort of laughs. He can defer RMDs until that day.
More commonly, we see clients continuing to work part-time in retirement. For anyone who is still working, and for employer retirement plans who accept rollovers into the plan, you may be able to roll funds from your IRA into your current employer plan and avoid RMDs on a much larger chunk of money. This is the definition of the tax tail wagging the investment dog, which most textbooks caution against. But if you’ve got a good retirement plan at work and don’t plan to stop working, it may make sense.
Most retirees spend more than their RMDs every year, so this is really an uptown issue for those who are really focused on taxes, as we are in our practice. It is important to note that there are very few ways to completely eliminate the tax consequences, as you would if you did a qualified charitable distribution, so it’s important to note that there is no prize for being the best tax deferrer. It only makes sense if your future tax rates will drop.
*Guarantees are subject to the claims-paying ability of the issuing insurance company.
This article is provided for informational and educational purposes only and should not be construed as investment, tax, or legal advice, or as a recommendation regarding any particular strategy. Whether a Roth conversion is appropriate depends on an individual’s financial circumstances, tax situation, investment objectives, and applicable law. Tax laws are subject to change and their application may vary. Examples discussed are hypothetical and are intended solely to illustrate general planning concepts. They do not reflect the experience of any specific client or guarantee future results. Consult your financial, tax, and legal advisors before implementing any strategy.