In March, we learned about the Required Minimum Distribution (RMD) rules and how they apply to tax-deferred retirement plans, such as 401(k)s, the Thrift Savings Plan (TSP), and Traditional IRAs. By design, RMDs are the Internal Revenue Code’s mechanism for forcing you to distribute, and pay tax on, the money in your tax-deferred retirement plans. But what if you’re fortunate enough to not need the RMDs? What are your options?
RMD rules apply to all employer-sponsored retirement plans as well as Traditional IRAs and IRA based plans, such as SEP and SIMPLE IRAs. While Roth IRAs are not subject to RMDs, Roth 401(k)s and the Roth TSP are. Generally, you must take your first RMD in the year you turn 70 ½, but if you are still working, you don’t have to take your first RMD from your current employer’s retirement plan until the year you separate from service. Once RMDs begin, you must continue taking an RMD each subsequent year.
If you don’t need an RMD, there are several strategies you may want to consider, but I’ll first start off by explaining what you can’t do with your RMDs. For starters, there’s a 50 percent penalty on any RMD you fail to take, so the last thing you want to do is avoid taking an RMD. You’re not permitted to take an RMD from one retirement plan and put it into another retirement plan. For example, you can’t take an RMD from your TSP and put it into an IRA. You’re also not permitted to convert an RMD to a Roth IRA. Once the money is out, it’s out – that’s the point of RMDs.
That doesn’t mean you’re forced to park the money in the bank, though. If you don’t need the money now, but may need the money later, you can always put the money into a non-retirement investment account and invest it based on your goals and objectives. In fact, we have many clients who do exactly that. Often times we simply transfer the value of the RMD (minus a little bit for taxes, of course) from their IRA to their brokerage investment account. This satisfies the RMD while getting the money back into investments as quickly as possible.
Furthermore, depending on your employment status, the extra cash flow may allow you to start contributing, or increase your contributions, to your employer’s retirement plan or to a Roth IRA if eligible. As previously mentioned, if you’re still working after 70 ½, you don’t have to take RMDs from your current employer’s retirement plan until you stop working. It’s, therefore, possible to delay RMDs by transferring eligible non-current employer retirement plans to your current employer’s retirement plan.
If you’re charitably inclined, consider using the Qualified Charitable Donation (QCD) for your RMDs. The QCD is a charitable contribution made directly from an IRA to your charity of choice. You may donate up to $100,000 ($200,000 for couples filing jointly) with the QCD, and the value of the QCD will go towards satisfying your RMD without you having to report the QCD as income. One drawback to the QCD, however, is it may only be used with an IRA and not an employer-based retirement plan, such as a 401(k) or TSP.
You could also use your RMDs to make lifetime gifts to your heirs. Your kids and grandkids could use the money to fund their employer’s retirement plan, or a Roth IRA, if eligible. The additional years in a tax-advantaged retirement plan could prove hugely beneficial. Lifetime gifts may not only make financial sense, but you’ll get personal gratification seeing the money benefit your kids and grandkids.
Continuing with the gifting theme, funding a 529 Plan for your heir’s college education is another option. Besides providing your heirs with a valuable gift, you may benefit from a state income tax deduction as well. Perhaps the biggest benefit, though, comes from the tax-free withdrawals when the 529 Plan money is used for qualified education expenses. Although your contributions to a 529 Plan are considered a completed gift, you still maintain full control of the money for as long as you remain the owner of the 529 Plan. This means you always have the option to pull money out of the 529 plan for your personal use. You may have to pay income tax and a 10 percent penalty on the earnings, but it’s an option if you ever find yourself in need of money.
While you can’t convert an RMD to a Roth IRA, you may convert money after you have satisfied your RMD. The funds from the RMD could be used to pay the additional taxes owed on the conversion, and since Roth IRAs are not subject to RMDs, any amount you do convert will reduce future RMDs.
Be sure to think long-term if you want to maximize the value of your retirement accounts.