How to Delay the IRS From Taxing Your Savings

How to Delay the IRS From Taxing Your Savings

If you’ve been working for a midsize or larger employer, chances are you’ve been utilizing a 401(k) to save for retirement. And even if you haven’t, you probably have an Individual Retirement Account (IRA) into which you’ve been saving every year. The great thing about these savings accounts is that the IRS gives you a deduction for the contributions (with some exceptions) and also allows the earnings to grow tax-free during your working years. But all good things much come to an end at some point. While the IRS may be patient, they are not a charity. After you turn age 71, they require you to begin to withdraw the money you’ve accumulated in these accounts, and will tax it at your highest marginal tax rate. But did you know that there are now two things you can do to delay the taxation beyond age 71?

Your first option is to simply keep working. If you have an active 401(k) with your employer you will not be required to take minimum distributions until you stop working. You can even continue to contribute to it, further adding to your tax-deferred savings. Unfortunately the same cannot be done with your IRA accounts. However, depending on your 401(k) plan’s features, you may have the option of rolling over your IRA into your 401(k). That will allow you to delay the taxation across all your tax-deferred savings. Many plans allow this. Be careful, though, if you are a major owner (5% or more) of the company offering the 401(k). In that case you will have to begin the required minimum distributions (RMD) starting at age 71 even if you haven’t retired yet.

There’s a second option, this one involving your IRA, which will allow you to defer RMDs. You can now purchase a qualifying longevity annuity contract (QLAC) inside an IRA. A QLAC – more commonly known as a deferred income annuity (DIA) – is a type of annuity in which you pay the premium up front (e.g. at age 65) but don’t start collecting the income until a certain number of years later (e.g. beginning at age 75 or even age 85). The IRS does not count your investment in the DIA as part of your IRA balance. Therefore your RMDs will be consequently smaller than they would have been without the DIA in the account, and the tax on the distributions consequently lower. There is a limit as to how much you can contribute to the DIA within your IRA: up to 25% of the account balance or $125K, whichever is less. But it is another way to reduce the taxes you need to pay to the IRS starting at age 71, and does not require you to have a 401(k) to do it.

Although delaying or reducing RMDs might be tax-beneficial during your early 70s, keep in mind that your future RMDs will be larger and involve higher taxes. Your goal should be to reduce taxes over your entire lifetime, not just in a single year, making tax optimization a pretty complex challenge. For that reason it’s best to discuss the myriad options available to you with your tax accountant or financial planner.


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