Ask an Advisor: I Have 2 Annuities and RMDs Looming. What Can I Do to Minimize Taxes and Possibly Reinvest the Money?

I’m 68, single and retired. I started claiming Social Security at 65 and my house is paid off completely. I have two fixed annuities: one for $300,000 at 5.5%, due to mature in 2026, and one for $100,000 at 4.5%, due to mature in 2028. RMDs are looming in five years when I will be 73. I don’t need the money as I have CDs, stocks and savings. What advice can you give me regarding the two annuities to minimize taxes and ways to possibly reinvest the money. Thank you for your help in this matter and keep up the great articles. – Liam

You do have some options that can help you manage your required minimum distributions (RMDs) and the resulting taxation of those annuity payments. We can talk through them, but as always, consider these options within the context of your broader financial plan.

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The Purpose of RMDs

RMDs are often a source of frustration, as they increase taxable income and draw down retirement account balances, prompting many people to look for ways to lessen their impact. There’s a reason for this: They are expressly designed to increase your taxes and decrease your account balance. Congress created them for that exact purpose.

You calculate your RMD by dividing your account balance (as of December 31 of the preceding year) by your life expectancy factor from the appropriate IRS life expectancy table.

I like to point that out just so people understand what it is they are trying to navigate. It’s not easy, but there are ways to manage your RMDs, especially if you look ahead as you are doing now.

For the benefit of other readers, it may also be helpful to point out that the annuities we’re talking about are qualified annuities, meaning they were purchased with money inside a tax-deferred retirement account, and that’s why RMDs are in play. (And if you need help planning for RMDs and limiting their tax impact, speak with a financial advisor.)

Simply Withdraw From the Account

The simplest option you have is to start withdrawing from the account once the annuities mature. This may feel counterintuitive to withdraw from a tax-deferred account when you have other sources of income that wouldn’t be taxed. Depending on your lifetime spending projections, this could smooth out your tax liability and give you a lower long-term tax bill. This is especially true if you are in a low tax bracket now, but expect RMDs to push you into a higher bracket later.

This strategy loses some of its appeal if your current tax bracket isn’t lower than the one you expect to be in the future, so it helps to weigh the numbers carefully. (And if you need help planning for taxes in retirement, see what a financial advisor can do for you.)

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Do Partial Roth Conversions to Lower Your Balance

Another approach, if you’re currently in a lower tax bracket, is to complete a series of partial Roth conversions over the next several years. Your annuities may need to mature first, although some insurers allow earlier conversions. Gradually shifting funds out of the IRA reduces its future balance, which leads to smaller RMDs.

For example, suppose you convert $50,000 per year for the next five years. That’s a total of $250,000 that you would gradually remove from your tax-deferred IRA. You’d have a fairly small balance left that would be subject to RMDs.

The tax savings tend to drive this strategy, but if flexibility is something you care about, it could still make sense even if you don’t save much on taxes. A Roth IRA avoids RMDs altogether, giving you the freedom to withdraw funds on your own schedule. (Connect with a financial advisor if you need help deciding whether a Roth conversion is appropriate for you.)

Before deciding on next steps for your retirement income plan, check your numbers with our easy-to-use RMD calculator.

Required Minimum Distribution (RMD) Calculator

Estimate your next RMD using your age, balance and expected returns.

Quickly estimate your RMDs and when to take them

RMD Amount for IRA(s)

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RMD Amount for 401(k) #1

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RMD Amount for 401(k) #2

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About This Calculator

This calculator estimates RMDs by dividing the user's prior year's Dec. 31 account balance by the IRS Distribution Period based on their age. Users can enter their birth year, prior-year balances and an expected annual return to estimate the timing and amount of future RMDs.

For IRAs (excluding Roth IRAs), users may combine balances and take the total RMD from one or more accounts. For 401(k)s and similar workplace plans*, RMDs must be calculated and taken separately from each account, so balances should be entered individually.

^*The IRS allows those with multiple 403(b) accounts to aggregate their balances and split their RMDs across these accounts.

Assumptions

This calculator assumes users have an RMD age of either 73 or 75. Users born between 1951 and 1959 are required to take their first RMD by April 1 of the year following their 73rd birthday. Users born in 1960 and later must take their first RMD by April 1 of the year following their 75th birthday.

This calculator uses the IRS Uniform Lifetime Table to estimate RMDs. This table generally applies to account owners age 73 or older whose spouse is either less than 10 years younger or not their sole primary beneficiary.

However, if a user's spouse is more than 10 years younger and is their sole primary beneficiary, the IRS Joint and Last Survivor Expectancy Table must be used instead. Likewise, if the user is the beneficiary of an inherited IRA or retirement account, RMDs must be calculated using the IRS Single Life Expectancy Table. In these cases, users will need to calculate their RMD manually or consult a finance professional.

For users already required to take an RMD for the current year, the calculator uses their account balance as of December 31 of the previous year to compute the RMD. For users who haven't yet reached RMD age, the calculator applies their expected annual rate of return to that same prior-year-end balance to project future balances, which are then used to estimate RMDs.

This RMD calculator uses the IRS Uniform Lifetime Table, but certain users may need to use a different IRS table depending on their beneficiary designation or marital status. It's the user's responsibility to confirm which table applies to their situation, and tables may be subject to change.

Actual results may vary based on individual circumstances, future account performance and changes in tax laws or IRS regulations. Estimates provided by this calculator do not guarantee future distribution amounts or account balances. Past performance is not indicative of future results.

SmartAsset.com does not provide legal, tax, accounting or financial advice (except for referring users to third-party advisers registered or chartered as fiduciaries ("Adviser(s)") with a regulatory body in the United States). Articles, opinions and tools are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. Users should consult their accountant, tax advisor or legal professional to address their particular situation.

Consider a Qualified Longevity Annuity Contract (QLAC)

A qualified longevity annuity contract (QLAC) is a type of deferred income annuity that meets certain criteria that allow you to exclude its value from RMD calculations.

You may use up to $210,000 to purchase an annuity whose payouts, among other things, begin no later than your age 85 but can begin earlier. By doing so, whatever amount you pay for the annuity is not included in your RMD calculation. It is considered to have met the requirement.

You may be able to exchange your existing annuities for a QLAC depending on your contract and whether you are within a surrender period. Otherwise, you may need to wait until they mature.

Some brokerages make QLACs available on their platforms, while others do not. If yours doesn’t, you may transfer all or part of your retirement account to a firm that does offer them or purchase one directly through an insurer. (A financial advisor can help you assess whether a QLAC is a viable option for your retirement income plan.)

Charitable Contributions

Qualified charitable distributions (QCDs) let you send money directly from your IRA to eligible charities, and those amounts are excluded from your income. That’s a meaningful distinction from withdrawing the money first and then making a donation.

A QCD never shows up in your income, so it doesn’t affect your adjusted gross income (AGI). You avoid taxes on the amount whether you itemize deductions or take the standard deduction. Because it reduces AGI, a QCD can also influence eligibility for other tax provisions tied to AGI and may affect how much of your Social Security benefits are taxed.

Taking the distribution first and then giving it to charity means it is included in your AGI, affecting other taxes and credits, and the taxability of your Social Security benefits. You only benefit from a deduction if you itemize.

Furthermore, QCDs can help satisfy some or all of your RMD requirements. Just keep in mind that you have to wait until age 70 ½ to be eligible for a QCD. (A financial advisor can help you weigh the pros and cons of QCDs and other tax strategies.)

Bottom Line

While it’s perfectly reasonable to want to avoid RMDs and taxes on your retirement income, I always stress the importance of evaluating action items in regard to how they fit into your overall plan.

Sometimes, what may sound good tactically (reducing your taxes in the near term) may not be the best move strategically (managing your total tax liability over time), and vice versa.

Consider each move in its entirety, not just for its ability to reduce your RMDs or taxes. For example, does a QLAC fit because you have concerns about longevity and it aligns with your distribution plan? If not, it probably makes very little sense to buy one for the sole purpose of avoiding RMDs.

Retirement Planning Tips

Beyond simply contributing, it helps to understand how different accounts fit together. Mixing traditional and Roth accounts can give you more flexibility later, letting you choose where to withdraw funds each year based on your tax bracket, expected RMDs and overall income needs.
Advisors can build projections that weigh different retirement ages, income sources, withdrawal strategies and market environments. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.