Strategies To Make The Most Of Your Required Minimum Distributions

I was doing some workshops for a group of pre-retirees (talk about envy!) and we were going over a lot of the basic questions that group often has:

  • How do I know if I have enough money?
  • How do I plan for medical costs?
  • What should I do about my investment allocations?

But the question that seemed to generate a lot of interest was if there were any strategies surrounding taking the Required Minimum Distribution (RMD), which is when you have to begin withdrawing funds from 401(k) accounts, pre-tax IRAs and some annuities at age 70 1/2. The strategies listed below can help you be more efficient in deciding which dollars you should consider using to pay your RMD.

Consider the number of retirement accounts you have

A lot of people have a misconception that if you have several retirement accounts you need to withdraw the required amount from each account. While you can do that, it’s important to understand what you’re allowed to do, since it varies by account type. 

If you have more than one IRA, you have a choice to withdraw each account’s required amount or you can take the combined distribution from one account. An important consideration here is that you cannot group your employer sponsored plan(s) like a 401(k) into this strategy. If you have more than one 401(k) (including Roth!) you would actually need to figure out the RMD from each 401(k) separately and withdraw from each one.

What investments do you currently have?

What if you have an investment that is doing very well and it’s time for you to take your RMD, do you absolutely have to sell that investment? Well if it is your only investment holding yes, but many people have more than one holding. 

Consider selling an investment that is not returning as much as others, i.e. dollars that you have in a money market account or perhaps a mutual fund you’ve been thinking of selling anyway. This can also provide an opportunity for re-balancing. 

For example, say you have too much in bonds, by selling off a portion of bonds you can make your RMD and get back to a percentage in bonds that you are comfortable with.

Re-investing your RMD if you don’t need the money

What happens if you don’t need the money that the RMD forces you to take? (I know, nice dilemma!) Well you still have to take it, unless of course you like the penalty for not taking it (50% of the amount you should have taken). So what are your choices? 

Of course you can spend it, I mean after all you worked hard for it, but you could also re-invest. Some things to consider might be tax efficient investments, such as municipal bonds or if you are working, consider funding a Roth IRA where future growth can be pulled out tax free (after you have held the account for 5 years). 

Consider a charitable donation strategy

If you must take an RMD and you normally donate to charity, consider making your donation directly from your IRA account. This is called a Qualified Charitable Distribution and can help lower your taxes, especially if you no longer itemize your deductions because the standard deduction is so much higher than it use to be. You can give up to $100,000 from your IRA each year in this way. 

For example, say your RMD for the year was supposed to be $10,000 and you normally give $2,000 to charity each year. You could have the $2,000 sent directly from your IRA to the charity and withdraw the remaining $8,000 RMD from your IRA account. That way, you would not have to pay tax on the $2,000 donated to charity. 

If you are in the 22% tax bracket, then you would save $440 in taxes by doing it that way. Otherwise, with a $2,000 charitable donation, you may not be able to itemize your deductions to receive a tax benefit. See IRS Pub 590-B “Qualified charitable distributions.” section for more information.

Bottom line, just because you have to take your RMD, doesn’t mean you can’t be tax efficient by re-investing the money!

Keep in mind that your strategy may be quite simple or may employ some of the above tips, but the one constant is that you want to continue to be on time with your RMD and whenever possible, make it as advantageous for you as you can.

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