Starting April 1st of the year after you turn 70½, and every year thereafter, you will have to begin taking required minimum distributions (RMDs) from your IRAs or be subject to IRS fines and penalties of up to 50% of the amount you should have withdrawn. For most retirees, these distributions provide much needed additional retirement income. But for wealthy individuals with plenty of other income sources to ensure a comfortable retirement lifestyle, these required distributions can prove more headache than help.
Because the amount of your RMD is calculated based on your total retirement account balances and your average life expectancy, the income generated from annual distributions for wealthy retirees can potentially be large enough to force you into a higher tax bracket. The more common challenge, however, is that many parents and grandparents who don’t need to rely on their IRAs for income, would prefer to preserve those assets as a legacy for the next generation.
Consider enacting a Roth conversion
If you are in your 50s or early 60s, you still have plenty of time to consider converting some of your traditional IRA assets into a Roth IRA where the money can continue to grow tax-free1 without any future distribution requirements. The downside is that any tax-deferred assets converted into a Roth are considered taxable income for the year in which they are converted. But paying taxes upfront may prove advantageous in the long run, and your advisor can help you explore strategies where you can stage a Roth conversion over a number of years to help minimize its impact on your taxable income.
In addition, with a Roth IRA your heirs inherit an asset that’s unencumbered by taxes. Whereas distributions from inherited traditional IRAs must be reported as taxable income, Roth beneficiaries need not pay taxes on distributions as long as the account is at least five years old.
Use your RMDs to fund life insurance
Perhaps a Roth conversion doesn’t make sense for your particular circumstances, or maybe you’re too close to age 70½ to gain much benefit from the strategy. In that case, you may want to explore using your RMDs each year to pay the annual premiums on a life insurance policy that can enhance the legacy you leave to your heirs as well as avoid estate taxes if applicable.
While you’ll still be paying taxes on your RMDs, the death benefit associated with a permanent life policy will typically be significantly larger than years of accumulating RMDs in low-risk investment vehicles. And when you die, your beneficiaries won’t have to pay taxes on any of the insurance proceeds they receive.
For those with significant wealth who are concerned about estate taxes, rather than holding the policy in your name (where it will be deemed part of your estate), ownership can be transferred to an irrevocable life insurance trust (ILIT) in order to remove the proceeds from your estate.
Of course, neither of these strategies may be appropriate for your situation. But they illustrate that there are creative ways to turn unwanted RMDs into a more robust legacy for future generations. Your SunTrust advisor will be happy to help you explore the various options available and determine the best course of action.