Five Ways to Make the Most of Them
Tax-deferred retirement accounts are the most commonly used vehicle for putting away retirement savings. In most cases, the money is contributed on a pre-tax basis and the earnings are allowed to snowball along the way without taxation. However, when you reach the age of 72, the IRS wants to make up for lost time by requiring you to begin taking required minimum distributions (RMDs).
RMDs can be an unwelcome necessity for many retirees, especially if they don’t need the income. If you don’t take your RMD in a given year, you’ll be subject to substantial penalties. The penalty is 50% of the value of your RMD in addition to taxes owed on the full RMD. Yikes! So, you definitely want to take your RMD on time. That said, RMDs do trigger a taxable event that can increase your income tax liabilities, potentially moving you into a higher tax bracket. As you approach age 72, it’s a good opportunity to do some tax planning so that you aren’t surprised when RMDs kick in. Here are several tips that can help you make the most of your RMDs.
#1 – Invest
Just because you’re required to withdraw money from your retirement accounts doesn’t mean you’re required to spend it. If you wish to continue growing your assets to cover future expenses or leave a legacy for family members, you may want to consider reinvesting your RMD assets in a taxable account. The benefit of this approach is that those dollars get put back to work, and any gains on assets held at least one year are taxed at favorable long-term capital gains rates.
#2 – Donate
Once you reach age 70 ½, you’re eligible to make a direct transfer from your IRA to a 501(c)(3) organization via a qualified charitable distribution (QCD). A QCD counts toward your RMD amount, but because it’s transferred directly to a charity, it’s not taxable and lowers your adjusted gross income (AGI). This strategy is better than taking your RMD and then making the donation because your AGI is used in many tax calculations (such as taxation on Social Security income). Both married and single individuals can donate up to $100,000 each year from an IRA through a QCD. It’s important to note, however, that the amount of the QCD cannot also be claimed as a charitable deduction, as you’re already receiving a tax benefit on the donation.
#3 – Choose whether to spread it out or take it in a lump sum
How you should take your RMD depends on whether it’s part of your retirement income plan.
If you will be spending the income from your RMD, it may make sense to calculate your yearly distribution and withdraw a portion of it each month (or quarterly). This may help with your monthly budgeting, and it’s better than having a whole year of spending sitting in your bank account. Also, taking monthly sums is the reverse of dollar cost averaging, which ensures you won’t be forced to withdraw a large amount during a market correction.
The other school of thought on RMDs is to leave them until later in the year and take a lump sum before the deadline. This strategy maximizes the benefit of tax deferral, as your RMD funds have more time to grow, also allowing for the potential of additional interest and dividends. Due to the market’s upward bias and higher frequency of positive years to negative, waiting has a high probability of benefitting the investor.
#4 – Don’t delay
As a retiree, you have until April 1 of the calendar year following the year you turn 72 to take your first RMD. In subsequent years, you must take your RMD by December 31. While it may seem wise to delay your RMD for as long as possible in this first year, this is typically not the best strategy. Because you’ll also need to take the current year’s RMD by December 31, you may push yourself into an even higher tax bracket by taking out two RMDs within the same calendar year. Instead, it may make more sense to take your first RMD during the year in which you turn 72.
#5 – Enjoy
If you’ve figured out your monthly living expenses and are living a comfortable retirement within your budget, there’s no reason you can’t spend your RMD on something fun. So go ahead and book that trip you’ve been dreaming of. You deserve it!
Do you need help planning for retirement? Creative Planning is here for you. Our experienced teams take time to get to know you, your current financial situation, your goals for the future and any challenges you may face before offering well-informed, custom solutions to meet your needs. For help with your retirement income strategy, or with any other financial matter, please schedule a call with a member of our team.
For more information about RMDs, visit IRS.gov.