When most people think of their IRA account, they think of it as part of a nest egg for their retirement but they don’t give a lot of thought regarding strategies for maximizing the effectiveness of their IRA.
For example, many retirees postpone tapping their IRA until they are required to do so at age 70 ½. Their thought process is, “Why would I pay any income taxes before I absolutely have to?” As you know, IRS rules require that you begin taking Required Minimum Distributions (RMDs) from your IRA by April 1st of the year following the year you turn age 70 ½. However, most people take their first distribution before December 31st of the year they turn 70 ½ because if they wait until the next year, they must make two distributions and double up on their taxes in that year.
Strategy #1: Withdraw IRA money early. The two advantages of waiting as long as possible before taking a distribution from your IRA is that all your IRA money continues to grow tax deferred and you postpone paying income taxes. However, we have found that in many actual client cases, by taking money out early, the amount of total taxes paid can be less. In order to decide if an early distribution makes sense, we run a ‘trial’ income tax estimate prior to the end of the year. Often, we find the client is in a low marginal tax bracket with room left to take additional income (an IRA distribution) within that same bracket. The trick here is to run the trial tax return before the end of each calendar year and determine if taking a distribution (and how much) makes sense. You’ll want to compare this to a guesstimate of continuing to accumulate money in the IRA until Required Minimum Distributions begin. By waiting, we often find that later distributions must come out at a much higher tax bracket.
Some of the best IRA strategies are imbedded in how you set up your beneficiary designations. For couples, typically the beneficiary is the spouse. The big advantage of a spouse as beneficiary, is the surviving spouse can rollover the deceased spouses’ IRA into his or her name without any tax consequences. Could it ever make sense to skip the spouse as beneficiary?
Strategy #2: Skip your spouse. Let’s think outside the box for a moment. Assume a (younger) wife has named her husband as beneficiary of her IRA. Let’s also assume he does not need the money for his retirement. Instead of him receiving the IRA and doing an IRA rollover into his name, would it make sense to name a grandchild as beneficiary? The grandchild would need to take RMDs but they would be based on his or her life expectancy and the distributions would likely be at a much lower income tax bracket. This strategy could also apply to a child but the RMDs would be higher. Also, this is not an ‘all or nothing’ proposition. You could name a portion of your IRA to a non-spouse beneficiary. Note: in some circumstances, the spouse must provide written consent before you can change the beneficiary.
The real opportunities lay in either the contingent beneficiary (if you are married) or the non-spousal primary beneficiary(s).
Strategy #3: For an Inherited IRA, take a distribution sooner rather than later. Assume you are the beneficiary of your mother’s IRA. First, you must set up a properly titled ‘Inherited IRA’ account in your name. Once the account is set up, you are allowed to ‘stretch’ out the IRA distributions over your life expectancy if you take your first distribution by December 31st of the year following the year your mother died. A lot of people simply leave the money untouched in the account and by missing this deadline, the IRS rules require that all the money must be withdrawn within five years from the date of death of the IRA owner. The difference could be enormous. Next week, I’ll cover five additional strategies.