Picture this scenario: You worked hard for decades. You took advantage of every retirement savings opportunity you could. You contributed the maximum amount to your retirement accounts for the majority of your career. Due to compound growth on tax-deferred money, you’ve built up a substantial retirement nest egg.
Now you’re retired and you’ve reached the age you need to begin taking Required Minimum Distributions (or RMDs) from your non-Roth retirement accounts. And, because you’ve saved so much money in retirement accounts, your RMD is a lot of money—in fact, more money than you actually need to live on.
Sound like you, or the path you’re headed down? The good news is you have options.
It’s Called “Minimum” for a Reason
I know the question you’re probably asking yourself: Can’t I just take a smaller RMD?
The answer is no.
RMD is just like how it sounds–it is the minimum amount you need to take from your retirement account each year. Bluntly, it’s the IRS’s way of forcing you to take a certain amount of money from your tax-deferred retirement accounts so that they can get their taxes-owed.
RMDs are calculated based on the value of your non-Roth retirement accounts as of December 31 the previous year, then divided by a payout factor based on your age. As you age, the payout factor changes in order to increase your RMD.
When you take your RMD, you will owe ordinary income tax on the amount of money distributed (both federal and state, if you live in a state with income tax). The taxes can either be withheld from your RMD (meaning you will get a smaller amount of money in your bank account) or you can plan to pay the taxes when you file your annual income tax return.
What You Can and Can’t Do
Once you’ve taken your RMD and paid ordinary income taxes on that distribution, it’s your money to pretty much do what you please with.
- Want to reinvest it in your taxable (aka non-retirement) investment account? Sure.
- Want to keep it in cash for emergencies or unexpected medical expenses? Sure.
- Want to donate that money to charity? Sure. (But see below for a possibly better option.)
Want to gift it to someone? Sure. You can gift up to $17,000/year in 2023 ($18,000/year in 2024) to an individual without having to file a gift tax return.
What can’t you do?
Reinvest your RMD back in a retirement account.
You can only add money to a retirement account if you have earned income—meaning you went to work and earned the money (not investment income). Plus, you really wouldn’t want to do this anyway–despite the lure of tax-deferred growth, by adding money back to a retirement account you would theoretically have to pay ordinary income tax again when you take money out of the account. Plus, you would be increasing your future RMDS because you’re increasing the account value.
Are you RMD-age or older and still working? While you need to take RMDs from your IRA accounts (including SEPs and SIMPLE IRAs), you do not need to take RMDs from your employer-sponsored retirement plan (401k, 403b, profit-sharing, or other defined contribution plan). The exception to this rule, however, is if you are a 5% or more owner of the company, you must start RMDs at your RMD-age from your work retirement plan.
Still Looking to Avoid RMDs?
You have two options:
Option 1) Roth conversion
Roth IRAs do not require withdrawals (aka RMDs) until after the death of the owner. The IRS got its tax money from you when you made the contribution, so they don’t care if you do or don’t take money out of your Roth IRA in retirement.
If your retirement money is in tax-deferred accounts, you can convert that money to a Roth at any time, but the tax consequences of this decision need to be carefully considered.
Option 2) Qualified Charitable Distributions (QCDs)
QCDs are a way for retirees to donate their RMD directly from their retirement account to charity. This allows them to avoid paying ordinary income taxes on that RMD while supporting their favorite non-profit organizations. If you’re charitably inclined, this can be a great—and often overlooked—option.
Need Help Figuring Out What Your RMD May Be?
Monument can help. Even if you’re decades from RMD age, Monument can use our planning and modeling software to project what your RMD requirement may be and review different courses of action, such as the impact of doing incremental Roth conversions in the years between when you retire and when you start RMDs (when your tax bracket may be lower).
Don’t worry, we don’t fit the sales-y stereotype. We’re more focused on offering straightforward advice that removes the anxiety of the unknown. Let us help you get clarity on your financial future.
