The first Baby Boomers turned 70½ on July 1, which means most of them have to figure out how to pay more taxes to the U.S. government. It takes a little edge off the half-birthday celebration, doesn’t it?

The oldest Boomers can still take advantage of strategies to minimize taxes, but the best approach might involve (as Boomers used to say) an attitude adjustment.

These taxpayers have been diligently putting savings in 401(k), IRA and other retirement accounts to pay for retirement. When they reach 70½ they must begin to take money out of those accounts to meet the statutory minimum of Required Minimum Distributions, or “RMDs” for short.

Boomer taxes loomTaxes on these retirement accounts, including your contributions, have been deferred, of course, until distributions begin. Government tax collectors are now happy because taxes on Boomers’ RMDs could total $2 trillion over the next several years.

What should be your approach to taxes on these retirement accounts, particularly if you’ve been able to defer until age 70½?

A strategy for taxes or for income

You can look at your date with 70½ in two ways and prepare either a tax strategy or an income strategy. I prefer to concentrate on income.

When the government authorized these retirement accounts while thinking about how to help people save for retirement, they were also figuring out how long they could put off the collection of taxes on those savings. In other words, they were looking out for a recovery of the tax benefits granted.

Retirees sometimes mistake RMDs as an income strategy. It’s not, for the simple fact that even if you choose to take the RMD every year, the following will happen:

  1. The amount of actual dollars distributed will vary every year as the market goes up or down, and
  2. Because of the tax formula for setting annual distributions, the amounts will eventually decrease later in life when you will probably need more money for late-in-retirement expenses.

Annuitize for income

A good income strategy provides reliable payments you can count from year to year.

First, think about purchasing a QLAC, a type of deferred income annuity that starts paying benefits at an age you choose, but no later than 85. You can buy a QLAC with money from these retirement accounts and the purchase price will be removed from your RMD calculation. Taxes on this money will again be deferred until you start receiving payments

Everyone should consider a QLAC to cover expenses in the second stage of retirement, when age- and health-related costs are likely to be higher, but there are other effective income strategies, too, depending on your specific circumstances.

Approaches tailored to you

My wife is a psychotherapist with her own practice. She is one of those Boomers who has been diligently adding to her personal 401(k) for years and is nearing the time she must receive RMDs.

She is continuing to work but would like to spend a little less time seeing patients. Instead of keeping all her money in the 401(k) until the RMDs kicked in, she converted those savings to an income annuity that will produce twice the cash flow – guaranteed — than her RMDs at the start would have. The money is going into her business account, which allows her to take a half-day or more off every week while not suffering any effect on her income. She owes tax on the annuity payments, but she’s OK with that because her income and workload goals have been met.

For myself, I have a QLAC and I have also moved part of my 401(k) into an income annuity. In addition, I worked with an advisory firm to allocate some of my stock portfolio to hedge against market losses that would affect my distributions. We call it an income protection account. It means I may not earn the highest return when stocks are soaring, but I won’t suffer reductions in distributions when the market inevitably goes down.

By considering all our retirement needs while balancing the effects of taxes and other pressures, my wife and I can predict what our income will be in retirement and know we won’t run out of money. It makes paying a share to the IRS much less painful – and retirement much more enjoyable.

If you have questions about RMDs and how to maximize income write to me at Ask Jerry. I answer all questions myself.