For high-net-worth retirees, Required Minimum Distributions (RMDs) present a significant challenge. RMDs are mandatory withdrawals from retirement accounts, starting at age 73. These mandatory withdrawals can create major complications for many retirees.
This article explores effective strategies to minimize RMD tax burdens for wealthy clients. We will examine various approaches that can help preserve wealth while aligning with broader legacy goals, including Roth conversions and charitable distributions.
Table of Contents
- Understanding RMDs and their tax implications
- Qualified charitable distributions as a premier RMD tax strategy
- Strategic Roth conversions before RMD age
- Leveraging Qualified Longevity Annuity Contracts (QLACs)
- Optimizing asset location across account types
- Timing strategic withdrawals before RMD age
- Coordinating RMDs with Social Security and other income sources
- Tax-efficient charitable giving beyond QCDs
- Creating your comprehensive RMD tax strategy
Key takeaways
- RMDs can significantly impact the tax situation of high-net-worth retirees, potentially pushing them into higher brackets, and triggering increased Medicare premiums through IRMAA surcharges, making proactive tax planning essential.
- Strategic Roth conversions before RMD age, along with qualified charitable distributions up to $105,000 annually, can help minimize the tax impact of mandatory withdrawals while supporting philanthropic goals.
- Proper asset location across different account types, combined with careful timing of withdrawals, and Social Security benefits, can optimize tax efficiency throughout retirement and preserve more wealth for future generations.
Understanding RMDs and their tax implications
To understand the full scope of RMD tax planning, let’s start with a quick overview of what RMDs are and how they are calculated. RMDs are mandatory yearly withdrawals from certain retirement accounts, required by the IRS to ensure that these funds eventually get taxed.
The IRS calculates Required Minimum Distributions (RMDs) using a deceptively simple formula: divide the retirement account balance as of December 31 of the previous year by a life expectancy factor from their Uniform Lifetime Table.
While the table gives uniform guidance, for high-net-worth individuals things get interesting. Although RMDs usually begin at age 73, there is a notable exception for those still working who do not own more than 5% of their employer’s company. Many clients consider delaying their first RMD to April 1 of the following year, but this strategy often backfires and forces two distributions within one tax year.
The tax burden does not stay static. As clients age, the IRS life expectancy denominator decreases each year, forcing increasingly larger and large withdrawals. What might start as a manageable distribution can grow into a significant tax burden.
Most RMD withdrawals get taxed as ordinary income, potentially creating a cascade effect. For wealthy retirees, mandatory distributions can push them into higher tax brackets. Even more concerning, they might trigger increased Medicare premiums through Income Related Monthly Adjustment Amount (IRMAA) surcharges, effectively creating a double financial penalty.
Qualified charitable distributions as a premier RMD tax strategy
For tax-conscious retirees, Qualified Charitable Distributions (QCDs) are a particularly powerful way to minimize RMDs. Once a client reaches age 70½, the client can transfer up to $105,000 (for 2024) directly from their IRAs to qualified charities without triggering a taxable event.
What makes QCDs especially attractive is their ability to satisfy RMD requirements without increasing adjusted gross income. This is invaluable for high-net-worth individuals hovering near tax bracket thresholds or Medicare premium surcharge limits. Unlike traditional charitable giving, QCDs deliver tax benefits even when clients take the standard deduction over itemization.
Additionally, the SECURE Act 2.0 introduced an intriguing one-time chance to opportunity to direct up to $54,000 to charities through a split-interest entity (SIE).
Qualifying SIEs include:
- Charitable remainder annuity trusts
- Charitable remainder unitrusts
- Charitable gift annuity (if funded by qualified charitable distributions)
This provision is a fantastic opportunity for wealth donors to combine philanthropy with long-term income planning. However, proper execution demands attention to detail. The transfer must flow directly from the IRA custodian to qualified 501(c)(3) organizations.
Note: Donor-advised funds do not make the cut, a limitation that often catches affluent clients off-guard.
Strategic Roth conversions before RMD age
One of the most powerful strategies for minimizing future RMD tax burdens involves converting traditional IRAs to Roth IRAs before reaching age 73. This can significantly decrease future required distributions for high-net-worth individuals.
The sweet spot for doing a Roth conversion is often during lower-income years, such as early retirement before Social Security benefits begin.
Over the past 25 years, a partial conversion approach—spread out across multiple years—has proven especially effective. This method prevents the conversion itself from pushing income into higher tax brackets while steadily chipping away at future RMD obligations.
Unlike non-Roth IRAs, Roth IRAs have no RMD requirements for the original owner. This unique feature is extremely advantageous. It allows tax-free growth to continue through retirement, particularly appealing for those focused on legacy planning and generational wealth preservation.
Market downturns, while emotionally challenging, often present a strategic opportunity for Roth conversions. Converting assets during these periods allows transformation of more shares at lower valuations, maximizing the potential for tax-free growth once markets rebound.
Leveraging Qualified Longevity Annuity Contracts (QLACs)
Qualified Longevity Annuity Contracts (QLACs) are sophisticated option in the RMD reduction toolkit. These specialized vehicles allow clients to invest up to $200,000 from retirement accounts into deferred income annuities that remain exempt from RMD calculations.
The QLAC exclusion effectively creates a “carve-out” that reduces the retirement account balance used to calculate annual RMDs. Instead of forcing distributions beginning at 73, income payments from QLACs can be delayed until as late as age 85, providing valuable tax deferral beyond standard RMD requirements.
While QLAC distributions do eventually face taxation as ordinary income, this strategic deferral aligns higher income with potentially higher healthcare costs in advanced age. In the US, where long-term care expenses can quickly deplete retirement savings, this alignment of increased income is particularly valuable.
Optimizing asset location across account types
Strategic asset location in another critical yet often overlooked aspect of RMD tax planning. The basic principle involves placing tax-efficient investments like growth stocks in taxable accounts while positioning tax-inefficient assets like bonds in tax-deferred accounts.
Some aspects of this approach surprise high-net-worth clients. They are often unaware that RMDs for 401(ks) and other employer plans must be taken separately from each respective account. This nuance demands careful planning to maintain the desired asset allocation across all accounts.
High-net-worth individuals should also consider maintaining sufficient cash (or cash equivalents within IRA accounts) to fund RMDs to avoid liquidation during market downturns.
In-kind distributions offer more flexibility yet, allowing clients to transfer securities directly from IRAs to taxable accounts without selling, thus satisfying RMD requirements while maintaining market exposure.
Planning for proper asset location should begin years before RMDs start. This advance approach allows coordination with overall portfolio rebalancing, tax-loss harvesting strategies, and creates a more tax-efficient retirement income stream.
Timing strategic withdrawals before RMD age
Taking strategically timed withdrawals from retirement accounts starting at age 59½ can help reduce account balances before RMDs begin. Pairing this with delayed Social Security benefits (until age 70) can be especially powerful, as clients benefit from an 8% annual increase in lifetime monthly payments for each year they defer past full retirement age.
The “filling the bracket” strategy makes this set-up even more powerful. This strategy involves taking just enough from retirement accounts each year to reach the top of a client’s current tax bracket without going over. Spreading withdrawals across several years often results in paying taxes at lower average rates instead of larger, forced RMDs later in retirement.
This approach requires careful monitoring, adjustments, and regular reevaluation. Market performance, tax laws, and client needs change, all influencing optimal withdrawal amounts. But for those who can implement it successfully, this strategy often provides greater control over their tax situation throughout retirement.
Coordinating RMDs with Social Security and other income sources
Factoring in Social Security benefits requires careful attention to combined income thresholds. RMDs can push total income into income levels where these benefits become taxable, making timing critical.
For married clients, strategically choosing which spouse begins taking distributions can help manage tax brackets and preserve retirement assets. This is especially important when there’s a large gap in account size or age that affects RMD timing.
Well-to-do clients often benefit from delaying Social Security until age 70, while taking strategic withdrawals from retirement accounts before RMDs become mandatory. This approach maximizes the guaranteed lifetime benefit while providing flexibility in managing taxable income during early retirement years.
Tax-efficient charitable giving beyond QCDs
Beyond QCDs, many other charitable giving strategies can also enhance tax efficiency. Bunching charitable contributions in alternating years can help clients exceed the standard deduction threshold, maximizing tax benefits in giving years.
Donor-advised funds present a flexible alternative when QCDs are not available or appropriate. These vehicles allow for an immediate tax deduction while distributing charitable gifts over time, providing both tax efficiency and donor flexibility. Donor-advised funds are often central to a family’s broader legacy planning strategy.
For clients with significant philanthropic intentions, consider charitable remainder trusts or charitable gift annuities. These sophisticated planning tools provide both income streams and tax benefits, while potentially reducing the impact of RMDs on overall tax liability.
Creating your comprehensive RMD tax strategy
The most effective RMD tax minimization approach combines multiple strategies tailored to each client’s specific financial situation, charitable intentions, and legacy goals. No single solution works for every client, but a carefully orchestrated combination of strategies can significantly reduce tax burden and honor their intentions.
Join Harness and elevate your practice by developing personalized RMD tax strategies that integrate wealth management and estate planning. Partner with us today to create comprehensive plans that help your clients preserve what matters most. Don’t miss the opportunity to enhance your services—connect with Harness now!
Disclaimer:
Tax-related products and services are provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth.” Harness Wealth Advisers LLC is a paid promoter and an internet-registered investment adviser. Registration does not imply a certain level of skill or training. This article should not be considered tax or legal advice and is provided for informational purposes only. Please consult a tax and/or legal professional for advice specific to your individual circumstances. This article is a product of Harness Tax LLC.
Content was prepared by a third-party provider and not the adviser. It should not be regarded as a complete analysis of the subjects discussed. Although we believe the content is reliable, it is not guaranteed as to accuracy and does not purport to be complete, nor is it intended to be the primary basis for financial or tax decisions.