Under current law, a person, once they reach 70 ½ years old, must begin taking a required yearly minimum distribution from a traditional IRA. The required minimum distribution amount that must be taken is based on the account balance on January 1 of each year divided by a factor for the age attained during that year. Law sets the factor for each age. As an example, a $100,000 IRA owned by a person who is 75 years old would have a factor of 22.9. The required minimum distribution would be calculated by dividing $100,000 by 22.9 resulting in a required minimum distribution of $4,367. There is no problem with taking more than $4,367. However, if you take less than the required amount, the IRS will assess a penalty equal to 50% of the shortfall.
We now have an alternative. Assuming you take appropriate action during 2016, there is a way to reduce the amount of the 2017 required minimum distributions. A new law that has recently been passed allows you to transfer a portion of your traditional IRA account to a new type of investment called a Qualified Longevity Annuity Contract (QLAC). During 2016, you can make a decision to spin off a portion of your traditional IRA into a QLAC and have that amount excluded from the 2017 required minimum distribution calculations. There is no tax cost to spin off a portion of a traditional IRA to a QLAC.
Continuing with the above example, assume that $25,000 is transferred into a QLAC account. The account balance for computing the required minimum distribution is no longer $100,000. It is reduced to $75,000. The age factor for age 75 remains at 22.9. However, the required minimum distribution will now be $3,275 ($75,000 divided by 22.9). As you can see, the required minimum distribution is reduced resulting in less taxable income and $1,092 stays in the account to continue to grow with the tax deferred until the money is actually withdrawn.
QLAC rules limit the amount that can be transferred to a lifetime total of either $125,000 or 25% of the traditional IRA account, whichever is less. A QLAC allows you to delay taking required minimum distributions on the amount in the QLAC until as late as age 85. This creates an additional deferral period of over 14 years between ages 70 ½ and 85.
This is a good alternative for someone who has a continuing income stream after age 70 ½ and may not need this money. The minimum distribution option for the QLAC can begin at any time between ages 70 ½ and 85 should your financial position change.
Qualified Longevity Annuity Contracts can be used by anyone and at any time. Anyone under age 85 with traditional IRA’s can convert monies whenever they choose to a QLAC until they reach the maximum amount of $125,000 or 25% of their account, whichever is less. The conversion can be done in a single lump sum transaction or in a series of multiple transactions.
I suggest that you give this some thought and see if it will be a good fit for you.