A Financial Planner Shares 5 Ways To Make The Most Of Your Required Minimum Distributions

Required minimum distributions. These three words can strike consternation, concern, and apprehension in many folks. Minimum distributions, or RMDs for short, apply to retirement savings you hold in a 401(k), 403(b), 457(b), or tax-deductible individual retirement account (IRA) including SEP and SIMPLE ones. As the name states, RMDs are not optional. Because you contribute pre-tax dollars to these accounts, or for IRAs, get a tax break for contributions you make, at some point, the chickens come home to roost — the IRS will get its cut.

Managing RMDs can be confusing because the amount changes every year based on your age, the value of funds in your account, and your life expectancy. Your account administrator may send you an annual notice about your RMDs, and may even calculate the amount for you. Whether or not that happens, you are on the hook for taking your RMDs on time every year once you reach age 72. You can calculate them using an online calculator like this one, or use those on the IRS, brokerage companies, or mutual fund providers’ websites. 

One reason RMDs can cause frustration is that the additional income can push folks into a higher tax bracket. In a way, that’s a nice problem to have. If you really need that income, paying more taxes as a result is not a bad tradeoff. But, if you don’t need your RMDs to meet your living expenses, you’d prefer more control over how and when to take them, or you’re worried about how taking large withdrawals from your retirement investments will affect your finances, the tax impact can feel more onerous.

While you can’t avoid RMDs, you can manage them. Here are five ways you can get the maximum benefit from your RMDs — including using them to fund living expenses, reinvesting them in an after-tax account so they continue to grow, and paying them forward to benefit loved ones.

1. Delay, Delay, Delay

Working longer means you can delay a portion of your RMDs. However, you don’t get an absolute pass. If you’re still working at age 72 and contribute to a pre-tax retirement plan offered by your employer, you won’t have to take RMDs from that account as long as you continue working and are not an owner. You will still be on the hook for RMDs from your other pre-tax retirement accounts such as those from previous employers.

2. Consider A Backdoor Roth

Doing a Roth conversion with assets you have in pre-tax retirement accounts is a way to reduce the number of your assets that will be subject to RMDs. Since Roth accounts are funded with after-tax dollars — money you’ve already paid taxes on — these accounts aren’t subject to RMDs. That means you get to decide when and how you’ll take distributions from these accounts, not the IRS. 

You need to know two things upfront. One, if you want maximum flexibility, consider doing this before you need to start taking RMDs. If you wait until you reach age 72 to do a conversion, you have to take your RMD first before you can convert the remaining funds in that account to a Roth. Two, no matter when you do the conversion, you’ll have to pay income taxes on funds you withdraw. That’s because you weren’t initially taxed on those funds or, for funds you put into a tax-deductible IRA, you received a tax deduction.

Pro Tip: If you’d like to do a Roth conversion, timing it for a year when your income is lower than normal, or your portfolio has taken a hit, can help reduce the tax bite. You’ll want to work with your tax professional and your financial advisor if you have one, so you’re fully up to speed on what the tax impact will be.

3. Contribute Your RMD Amount To Your Spouse’s Retirement Account

4. Fund A 529

Have grandkids or other loved ones whose education you’d like to help support? If you don’t need your RMDs, you can contribute them to a 529 Plan. Combine that with “bunching” or “superfunding” — combining several years’ worth of contributions into a single tax year — and you may be able to reduce your federal taxes (this only applies to taxpayers who itemize their returns). 

Pro Tip: Many states offer a tax deduction on contributions to their 529 plans.

5. Spread Out Your RMDs

You have to take RMDs on a schedule and according to a calculation the IRS sets. But, you don’t need to pull them out in a lump sum. Spreading your RMDs into quarterly or even monthly payments throughout the year instead of in one chunk at the beginning or end of the year has benefits. You can plan and make adjustments more easily by taking periodic payments than if you take your annual amount in one go.

Another big reason not to take your withdrawal all at once? Financial markets fluctuate.  There’s no way you can predict when or for how long markets will be down or up. Research has consistently shown that missing even a few of the stock market’s most profitable days can have a big negative impact on your investment returns. Spreading out your RMDs through the course of the year reduces the chance that you cash out right before a runup in the markets or just after they’ve cratered.

Pro Tip: If you don’t need your RMD, consider taking it as an in-kind transfer. This means you make the account withdrawal without cashing out of the investment. You simply transfer it from your retirement account to a taxable investment account. You’ll still have to pay income taxes on your withdrawal, but you aren’t forced to sell an investment just to meet your RMD requirement. 

It’s really important to think of and treat your RMDs as part of a larger whole. Along with Social Security, taxable investments, earnings from an encore career or freelance work, and pensions (for those lucky few), RMDs are one leg of your overall retirement income picture. While it can be frustrating to have to track large and fluctuating payments to make sure you don’t unintentionally skip one or withdraw too little, doing some planning and dynamic management will have you in good financial stead. 

At the end of the day, your RMDs are the fruits of your decades spent working. They should help enable you to spend your retirement years on the things that give you pleasure.