Saving for retirement is a lifelong endeavor. While you may be in the habit of saving and investing, you may also be required by the government to make a minimum withdrawal annually. Here's a closer look at required minimum distributions (RMDs) and what to do with your funds.
What is an RMD?
RMD is short for “required minimum distribution." RMDs apply to employer-sponsored retirement accounts and traditional IRAs. According to IRS rules, once you reach age 72 or 73, depending on your birth year, you must withdraw a specified minimum amount from your account yearly. Accounts subject to RMD rules include:1
- • 401(k) plans
- • 403(b) plans
- • 457(b) plans
- • Traditional IRAs
- • SEP IRAs
- • SIMPLE IRAs
- • SARSEPs
If you don't take the RMD, you risk incurring a 50% excise tax on the amount not distributed.2 For inherited retirement accounts, you may have to withdraw before turning 72 if the person who passed away would be required to withdraw.3
Tip: RMDs are required at age 72 if you turn 72 before December 31, 2022. Otherwise, they're required to start at age 73.1
How to Withdraw Your RMD
An excellent way to ensure you follow RMD requirements is to set up automatic withdrawals to avoid potential consequences. The deadline for your first RMD is typically April 1st the year after you turn 72 or 73. Subsequent RMDs are due by December 31st each year.2
To determine your RMD amount, divide your prior calendar year ending balance by a life expectancy number provided by the IRS. While the math can initially seem intimidating, the government offers worksheets to help you determine your RMD amount.
Depending on your investments, you may need to sell assets to fulfill your RMD. Plan ahead, as investment sales can take a few days to settle. Once you withdraw, you can use the funds however you'd like.
What to Do With Your RMD
When the RMD lands in your bank account, you have nearly unlimited options for using the cash. Remember to put aside a portion for taxes, unless you withdraw Roth-designated funds. Here are some of the most popular ways to use RMDs.
1. Use for living expenses
The default option for many households is to put the funds toward living expenses, which is the general reason they saved for retirement in the first place. Depending on your budget, savings and other income, your RMD could be a critical source of funds. Check out our guide on creating a budget, and consider how your RMD fits into your spending plan.
2. Pay down debt
Using your RMD for big-ticket items—such as paying off a home equity line of credit, a large medical bill or a student loan—may save you money on interest in the long run. Eliminating monthly payments can free up cash for living expenses, travel or anything else you value.
3. Save it
If you don't need the funds for necessities, put the money back to work for you by either saving it in a high yield savings account or certificate of deposit (CD). Cash in the bank is FDIC-insured, making it one of the safest places to put your money. Consider using your withdrawal to create an emergency fund or rainy day fund if you don't already have one.
4. Reinvest
Investing in stocks or bonds appropriate for your risk tolerance and financial goals can lead to a more significant long-term payoff. Exchange-traded funds (ETFs) and mutual funds offer diversified portfolios and may come with low fees. Consider the tax implications of investing if you're concerned about capital gains and other investment-related taxes.
5. Roll over into a Roth IRA
Roth IRAs have no RMDs. You'll have to pay taxes on the amount withdrawn from a traditional IRA, but you'd have to pay those taxes anyway. Once added to your Roth IRA, your investments grow tax-free.
6. Donate
If you've been thinking about making a charitable contribution and have an RMD to take, consider giving your RMD to a cause you care about. With a tool known as a qualified charitable distribution (QCD), you can transfer up to $100,000 each year directly to an eligible charity. Keep in mind that this works only for IRA withdrawals and not employer-sponsored plans, such as 401(k)s.4
7. Pass it on
Give your children or grandchildren the gift of an education by putting your RMD into a 529 college savings plan for a family member. In a 529 account, the money will grow tax-free, and withdrawals are tax-free as long as they go toward qualified education expenses. You'll still have to pay income taxes on the RMD, but the funds will go to a cause you believe in.
8. Treat yourself
If your essential expenses are met and you're living debt-free, you've earned the ability to use your RMD for fun. Plan a vacation, buy something you've always wanted or treat yourself to anything else. Now that you have a well-thought-out financial plan, you can finally spend on your most valuable asset—you.
Make the Most of Your RMD
Calculating your RMD, withdrawing and paying any required taxes may feel like a chore. But once you've taken your RMD, you're free to use your funds to better your financial situation or upgrade your lifestyle. As long as you live within your means and stick to your retirement budget, you can save, invest or enjoy the proceeds from your RMD.
Eric Rosenberg is a financial writer, speaker and consultant based in Ventura, California. He holds an undergraduate finance degree and an MBA in finance. He is an expert in topics including banking, credit cards, investing, cryptocurrency, insurance, real estate and business finance. He has professional experience as a bank manager and nearly a decade in corporate finance and accounting. His work has appeared in many online publications, including USA Today, Forbes, Time, Insider, NerdWallet, Investopedia and U.S. News & World Report. Connect with him and learn more at EricRosenberg.com.
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