Strategies to Avoid TSP Required Minimum Distributions and Minimize Medicare Part B Premiums

Previous columns discussed why federal retirees and annuitants over age 65 should enroll in both Medicare Part A (hospital insurance) and Medicare Part B (medical insurance). Federal annuitants over age 65 enrolled in Medicare Part A do not pay a monthly premium for Part A because they paid the Part A payroll tax as employees for at least 10 years. But there is a monthly premium for Part B. The amount an annuitant pays in monthly Part B premiums each year depends on the annuitant’s modified adjusted gross income (MAGI) from the previous year. The higher the annuitant’s MAGI, the more the Part B monthly premium. The following table shows what Medicare Part B enrollees are paying in monthly premiums during 2017:

Note that MAGI encompasses all income, including tax-exempt dividends and interest. As will be discussed below, part of a federal annuitant’s MAGI are required minimum distributions (RMDs) from the traditional Thrift Savings Plan (TSP). Every year federal annuitants age 70 and older must take RMDs from their traditional and Roth TSP accounts. With the Roth TSP RMD, the earnings portion of the RMD will not be included in income assuming the Roth TSP distribution has fulfilled the requirements of a qualified Roth TSP distribution.

In 2017, most new Medicare Part B enrollees pay a standard monthly Part B premium of $134.00. This also includes many Part B beneficiaries who do not receive Social Security benefits. For example, single CSRS annuitants who do not have at least 40 credits of Social Security and are not eligible for Social Security benefits pay $134.00 per month if their MAGI was less $85,000 during 2015.

But high income federal annuitants pay more in monthly premiums for Medicare Part B. These monthly premiums range from $187.50 to $428.60. Monthly premiums are per person. This means that a retired married couple would pay twice that amount. In looking at the 2017 Medicare Part B premium table above, that means a married couple in which both spouses are over age 65 and whose MAGI exceeded $428,000 during 2015 would pay in total more than $10,000 for Medicare Part B premiums in 2017.

Those federal annuitants who are Medicare Part B recipients and who are age 70 years and older are subject to required minimum distributions (RMDs) from their traditional TSP accounts as well as from their traditional IRAs and any other qualified retirement plans  (such as 401(k) or 403(b) plans) that they participated in during their working careers. These RMDs are included in their MAGI and if large enough, could result in the annuitant being catapulted into a higher Medicare Part B premium “tier”. Consider the following example:

Joseph, single and age 69, is a retired FERS annuitant and had a MAGI of $150,000 during 2016 and expects the same MAGI during 2017. Joseph becomes age 70 on June 25, 2017 and must make his first TSP RMD no later than April 1, 2018. Joseph decides to take his first TSP RMD during 2017 in order to avoid taking two TSP RMDs during 2018 (the 2017 TSP RMD due April 1, 2018 and the  2018 TSP RMD due December 31, 2018). His TSP account balance as of Dec. 31, 2016 was $500,000. If Joseph’s RMD exceeds $10,000, his 2017 MAGI will exceed $160,000, resulting in Joseph going into a higher Medicare Part B tier and paying more Medicare Part B monthly premiums during 2019.    

Qualifying Charitable Distribution

Fortunately, a federal tax benefit became permanent starting in 2016. A “qualifying charitable distribution” (QCD) allows a traditional IRA owner to directly contribute up to $100,000 from an IRA to a qualifying charity without recognizing the transferred IRA assets as income. Most importantly, QCDs count toward the donor’s RMD requirement.

The requirements for a QCD are relatively simple. The QCD must be: (1) From a traditional IRA or a Roth IRA: (2) directly sent from the IRA trustee to the charitable organization, with no intervening possession or ownership by the IRA owner; (3) performed after the IRA owner has reached age 70.5; and (4) a contribution to an organization that would qualify as a charitable organization under Internal Revenue Code Section 170(b)(1)(a).

Besides satisfying the annual RMD, a QCD has other tax benefits.  Perhaps one of the more important tax benefits is avoiding the percentage limitation on direct charitable contributions. Under the standard IRA distribution rules, if an individual withdraws $100,000 from a traditional IRA and donates the cash to a charity, the $100,000 has to be first included in gross income and then deducted as a charitable itemized deduction. The problem is that the donor’s $100,000 contribution deduction will run into the 50 percent of donor’s adjusted gross income (AGI) limitation. As a result, the donor will likely not be able to deduct the full $100,000 of the contribution in the year that the $100,000 is included in income. But whatever is not included as a charitable contribution because of the 50 percent of AGI limitation will still be included in the donor’s AGI, thereby resulting in additional tax. Note that a $100,000 QCD completely avoids that issue. By excluding the full $100,000 from gross income, the donor in effect gets a $100,000 “deduction” that is not included in income. Note that ,while the QCD satisfies the annual RMD, the QCD cannot be included as a charitable contribution on one’s income tax return.

Note also that the $100,000 is an annual QCD limit. This means a donor could make a QCD every year up to $100,000 per year. For example, if the donor owns a $2,000,000 IRA and is age 70, then the donor can make a QCD of $100,000 for 20 years.

For TSP account owners who want to take advantage of QCDs to avoid the TSP RMDs, it is important to note that the TSP does not make QCDs. Only IRAs make QCDs. If a TSP participant wants to use QCDs to avoid TSP RMDs once the participant becomes age 70, then the following steps must be taken:

Step 1. Transfer all of the participant’s TSP account directly to a traditional IRA. If the TSP participant own any other qualified retirement account such as a 401(k), 403(b), or 457 plans, then these accounts must also be transferred into the traditional IRA.

Step 2. Each year, the IRA custodian will determine the federal annuitant’s traditional IRA RMD. Based on that RMD amount, the annuitant can request a QCD to a qualified charity.

The result is that the annuitant will not have to include an RMD in income, resulting in: (1) Lowering overall taxes; and (2) possibly lowering Medicare Part B monthly premiums each year for the remainder of the annuitant’s life.

Ideally, an annuitant who retires from federal service before age 70 will transfer all of his or her TSP and other qualified retirement accounts before the year he or she becomes age 70. In so doing, the annuitant could potentially avoid RMDs entirely by taking advantage of QCDs annually.

Those annuitants who hire accountants to prepare their tax returns should mention that they are interested in QCDs. Most importantly, annuitants age 70 and older who make a QCD in any particular year should be sure that they tell their accountants. This is because currently a QCD is not being reported on a 1099-R, and the exclusion from income can be lost if the accountant never learns about it.