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An outside-the-box idea for taking your RMD

Robert Powell
Special for USA TODAY
Taking your requirement minimum distribution can cause a complicated tax situation.

Q: By the end of 2016, I will take the required minimum distribution from my IRA. Most likely this will also affect my Social Security income and make for substantial tax burden compared to past years. At 70½ this is a huge concern. Do you have any ideas as to how to cushion the blow? Donating funds and using this as a tax deduction is one, but what else is there? — Gary Urcheck, Ohio

A: We’ll start first with a few traditional tactics and then give you what one adviser calls an “outside-the-box” approach. First the traditional:

Consider buying a qualifying longevity annuity contract or QLAC inside your IRA. You can use up to 25% of your IRA (but not more than $125,000) to purchase an annuity from an insurance company. The QLAC helps reduce your RMD. The $125,000, or whatever amount is investing in the QLAC, is taken out of your "base" for computing RMDs on the rest of the IRA. Read  Treasury Issues Final Rules Regarding Longevity Annuities.

Consider, as you suggested, making qualified charitable distribution or QCD. A QCD, according to the IRS, is generally a non-taxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions.

How to put your RMD to work (and avoid a 50% penalty)

You must be at least age 70½ when the distribution was made. Also, the IRS says you must have the same type of acknowledgment of your contribution that you would need to claim a deduction for a charitable contribution. Of note, the IRS also says the maximum annual exclusion for QCDs is $100,000 and that any QCD in excess of the $100,000 exclusion limit is included in income as any other distribution.

Also, if you file a joint return, your spouse can also have a QCD and exclude up to $100,000, according to the IRS. The amount of the QCD is limited to the amount of the distribution that would otherwise be included in income. If your IRA includes nondeductible contributions, the distribution is first considered to be paid out of otherwise taxable income, says the IRS.

Ultimately, the QCD is a great way to do good and to reduce the IRA balance used to calculate your RMDs. One late note on this: Make sure the QCD/RMD is sent directly to a qualified charity of your choice by the IRA custodian.

Inherited IRAs come with RMD strings attached

Now for the out-of-the-box idea. Consider taking a large withdrawal — much larger than the RMD — and combining it with a charitable remainder trust (CRT) or a donor-advised fund (DAF), says Dave Spence, a certified financial planner with Palladium Wealth Management.

“This approach reduces the future RMDs, which means less future IRA taxes, potentially less inclusion of future Social Security income in your taxes, and lower future premiums for Medicare to be withheld from Social Security benefits,” he says. “What one pays in Medicare premiums is based on total reported income, so the large withdrawal may cause a one-year spike in that premium, after which, the regular amount to be withheld would potentially be lowered for many years.”

Now, he says the contribution to a DAF could be looked at as prepaying — and deducting — many future years of charitable contributions all at once, in the year of the large spike in income associated with the large IRA withdrawal.

He gave this example: If one normally contributes $5,000 per year to their church, they could put $50,000 into the DAF this year and send $5,000 each of the next 10 years from the fund, but get the entire $50,000 deduction this year.

“A charitable remainder trust or CRT is more complicated, but provides a current year tax deduction based on the amount contributed and the length and amount of the annuity that the CRT would pay to the donor before the balance would ultimately pass to a qualified charity,” says Spence.

He gave this example: A taxpayer withdraws $200,000 from his IRA, puts it all into a CRT, withdraws 4%, 5%, 6% — whatever amount he decides to build into the trust terms — for a fixed number of years or for the rest of his life. “Whatever remains in the CRT at the end of the annuity period passes to the charity, but the deduction (a calculated percentage of the $200,000) is deducted in the same year the large withdrawal is reportable,” says Spence. “The taxpayer, you in this case, could structure the CRT terms to maximize either the deduction or the annuity payments to suit his goals.”

Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email rpowell@allthingsretirement.com.

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