Reducing Taxes on RMDs & Social Security Benefits

It is rather shocking to realize that you could create an income plan for your retirement that could significantly reduce or eliminate altogether your RMDs (required minimum distributions). Reducing RMDs can impact Social Security benefit taxation by lowering the income includable in the provisional income test, sometimes lowering the threshold a full “tier.”

Employers have an opportunity to select a variety of ERISA plans for themselves as well as their employees. One plan often overlooked is a profit sharing plan. Its ability to use cash value life insurance is unique and it can be converted almost tax-free. If the life insurance policy is a non-modified endowment contract held in the profit sharing plan, an economic benefit will be annually assessed and trigger a relatively small ordinary income tax event each year it’s in the plan. Generally speaking, the money must be staged into the life insurance policy 3 years or more to comply with the TAMRA regulations. When you purchase the life insurance from the profit sharing plan for its market value, generally the cash surrender value; you access the cash values of the policy via loans tax-free.

Cash value life insurance uses collateralized loans from the policy to generate tax-free income. To maintain its tax-free status, the policy must be issued as a non-modified endowment contract and kept in force for the life of the policy insured. There are several crediting options available depending upon your risk tolerance.

Roth IRAs are a great funding option for those who are in a low effective tax bracket, but it’s also a great option to convert taxable qualified plans to. The conversion will cause an ordinary income tax event, but if you can strategically remain in your tax bracket by converting your qualified plans over time it could be beneficial. The ultimate goal is to convert taxable income to tax-free income before retirement.

The financial fantasy of greatly reducing RMDs or eliminating them altogether is a delightful possibility, but it requires a financial adviser that is a retirement income expert and is very knowledgeable in taxation law. Before moving forward with any of these ideas you should check with your tax consultant and insurance professional.