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A Little-Known Investment Option that Can Save a Bundle on Taxes

Once many people turn 70, they discover a very unfortunate part of the tax code. Not only are these folks mandated to start withdrawing a percentage of their retirement account funds (known as Required Minimum Distributions or “RMDs”) but such withdrawals can pump up their stated levels of income. And that can often lead to a large portion of Social Security benefits subject to taxation.

This is known as the “tax torpedo” and you can read more about that here.

But there’s a simple way to at least reduce that tax bite: Use Qualified Longevity Annuity Contracts, or QLACs. You can purchase a QLAC worth up to $125,000 with funds drawn from your retirement account, and when you start to receive monthly payments from that contract, the income is simply untaxed.

(As a reminder, an annuity entails an upfront investment today for a guaranteed stream of monthly payments later in life).

For example. If you have $375,000 in your retirement account when you turn 70, and one-third of that is invested in a QLAC, then only $250,000 of your retirement fund balance is subject to RMDs. The amount you required to withdraw each year will be lower and will enable you to keep more of your much-deserved Social Security payments.

No need to wait until your 70. The earlier you buy a QLAC policy, the greater the number of years it will have to grow in value until the payment phase of the annuity contract starts (known as “annuitization.”)

A few other points to consider. A guaranteed life income rider on an annuity ensures that once the annuity payments start, they will be in place for as long as you are alive. Annuity payments must start to flow to you by age 85 at the latest, but many people choose a date that is soon after their projected retirement date.

Lastly, you should focus on an annuity that has guaranteed minimum death benefits. This ensures that the value of the annuity (which grows higher over time) can be left to your estate to inherit. (However, that death benefit is taxable, unlike life insurance policy payouts).