16 Feb When IRAs make your tax bill go higher

Q. I don’t need my RMD but the income is making my overall income, and my tax bill, go higher. Is there anything I can do to offset this?
— Taxed enough

A. It seems as if you’re in a good financial position if you don’t need your annual required IRA distribution (RMD).

But like most of us, no matter our financial position, we like the idea of keeping our tax bill low. So with that in mind, here are several strategies you can use to try to offset the tax bill related to your distribution.

If you are charitably inclined, one way to reduce or eliminate or your IRA RMD is by gifting it to charity through what is known as an IRA qualified charitable distribution, or QCD, said Bryan Smalley, a certified financial planner with RegentAtlantic in Morristown.

“The IRS allows IRA owners over age 70 1/2 to gift up to $100,000 a year tax-free from their IRA to charity,” he said. “The QCD reduces the taxpayer’s income by reducing the amount of income the taxpayer needs to report on their tax return.”

For example, Smalley said, if your RMD for the year was $40,000 and you made a $10,000 QCD to your favorite charity, your reportable income on your tax return would be $30,000.

Smalley said given the recent tax law changes, the use of QCDs may become even more popular with fewer taxpayers itemizing their deductions — which includes charitable gifts made with cash or securities — and instead using the standard deductions, which are $12,000 for single filers and $24,000 for married couples filing jointly.

If you’re not charitably inclined, there are other options.

You could purchase qualified longevity annuity contract (QLAC).

A QLAC is a form of longevity insurance that is purchased from an insurance company, Smalley said.

“A QLAC typically does not start paying its owner until they turn age 85 and pays them for the remainder of their lifetime,” he said.

Smalley said the benefits of a QLAC is that the amount of your IRA that goes to purchase a QLAC — the lesser of 25 percent of IRA value or $125,000 — is excluded from your RMD calculation until age 85, when you begin to receive income from the QLAC.

“So depending on your current age, a QLAC could help reduce your IRA RMD for several years — but not indefinitely,” Smalley said.

That being said, it is important that you have a good understanding of what a QLAC is and the tradeoffs of purchasing one, Smalley said. The downsides of a QLAC may not trump the short-term tax benefits it may provide.

You can also consider a Roth conversion.

A Roth conversion is the converting of funds from a pre-tax traditional IRA into a tax-free Roth IRA and paying tax on the amount converted, Smalley said.

The major benefits of a Roth IRA are that the assets within grow tax free over your lifetime and there are no required distributions from the account, he said.

“It is important to note that a Roth conversion would not reduce your RMD in the year(s) you complete the conversion because the IRS requires that you take your RMD before you complete a conversion,” he said. “However, a Roth conversion would help to reduce future years’ RMDs because it would reduce the size of your IRA and therefore less would be required to be taken out each year.”

Your last option would be going back to work.

Smalley said if you’re over 70 1/2 and a participant in your company’s 401(k) plan, you are not required to take a distribution from your 401(k) while working as long as you do not own 5 percent or more of the company you are working for.

Assuming the 401(k) plan allows for it, you could roll your IRA into your 401(k) account and therefore not have to take any distributions on that money while you are employed, he said.

“You may be wondering: what about the employment income I would be receiving? Isn’t that going to add to the income I am trying to lower?” Smalley said. “It all depends on how much you earn and what you do with those earnings.”

You could decide to contribute all or most of your earnings — up to $24,500 for 2018 — on a pre-tax basis into your company’s 401(k). That would shield $24,500 of income from current taxation, Smalley said.

Of course, eventually the government will want its money and require that you start taking RMDs again once you retire, he said. But this could be a strategy that could help you reduce those RMDs for a few years and help you increase your nest egg at the same time.

Keep in mind all these moves are big ones, so we recommend you speak with a financial advisor before implementing any of these strategies.

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This post was first published in February 2018.