6 ways to use required minimum distributions in retirement

After focusing on saving for decades, shifting your retirement money mindset to withdrawing those savings could take some effort. But once you’ve retired, that might be exactly what you must learn to do—regardless of whether you need the money immediately.

If you have certain retirement accounts, such as traditional individual retirement accounts (IRAs) or 401(k)s, you must take RMDs, or required minimum distributions, from those accounts once you hit a certain age.

Here’s an overview of how required minimum distributions work, along with six ways you might use these savings.

The government introduced tax-deferred savings in the 1970s to encourage individuals to save for retirement. And, to ensure that retirees would eventually pay taxes on those accounts, the law set the age when withdrawals would be required to begin. You will have RMDs if you’re the original owner of tax-deferred retirement accounts including:

• Traditional IRAs
• 401(k)s
• 403(b)s
• 457(b)s
• SIMPLE IRAs
• SEP IRAs
• Defined contribution plans
• Profit-sharing plans

Note that Roth IRAs do not have RMDs. And starting in 2024, other qualified retirement plan Roth accounts, like Roth 401(k)s, won't either due to changes that were enacted in the Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0.

The act has also changed RMD age requirements. It used to be 72, but your RMD age will now depend on the year in which you were born.

If you were born in:

• 1950 or earlier: Your RMD start date is at age 72
• Between 1951-1959: Your RMD start date is at age 73
• 1960 or after: Your RMD start date is at age 75

If you turn 73 in 2023, you must take your first RMD by April 1, 2024. Then, in subsequent years, you should take the distribution by Dec. 31. If you delay your first RMD until the start of 2024, you may have to pay two distributions, one for 2023 and 2024.

If you're still working at your RMD age and don't own 5% of the company you work at, you may delay taking RMDs from that employer-sponsored 401(k) until you retire.

RMDs are taxable, and you must continue them until you deplete your account. If you don't take your RMDs, the SECURE Act 2.0 imposes a 25% penalty on the shortfall starting in 2023. If you fix your mistake during a corrections window, the penalty may drop to 10%. You still need to pay any penalty plus ordinary income tax due on the distribution.

Your RMDs are determined each year by dividing the account’s prior year-end value by a life-expectancy factor set by the IRS.

The easiest way to calculate your RMD is to ask the administrator of your account, but you can also calculate it yourself using a worksheet. You'll need:

• Your age
• Your account balance as of December 31 of the previous year
• The most recently updated Uniform Lifetime Table

Using your information and the table, look for the life expectancy factor associated with your age. For example, per the 2022 table, a 75 year old has a life expectancy factor of 24.6.

To determine the RMD, divide your account balance by the life expectancy factor. Using the example above, if that 75-year-old had $200,000 in a traditional IRA at the end of the previous year, that balance divided by 24.6 would put that person's RMD at $8,130.08.

The calculation is used for every qualifying account you own. Marital status only affects your RMD calculation if one spouse is at least 10 years younger than the other. In this case, use the IRS joint life expectancy table to calculate your RMDs.

It’s worth noting that, as the name suggests, your required minimum distributions are the minimum amount you can withdraw from your retirement accounts each year. Depending on your strategy for using the funds, you may choose to withdraw more. There are many ways to use your RMDs in retirement, and we’re highlighting six of them.

Many retirees use RMDs to cover routine expenses. Using the funds you worked so hard to save for your retirement lifestyle is a worthy goal, especially if you don't expect to be in a higher tax bracket during retirement since RMDs are taxed as ordinary income.

Think about how RMDs factor into your retirement budget. For example:

• Are you working part time?
• Do you have a pension partially funding your retirement?
• How much Social Security might you be getting?¹

A retirement income calculator can help you inventory your retirement income sources.

Saving your RMDs is another option. You may want to add to your emergency savings account so you’re prepared in retirement for unplanned expenses or medical costs.

Depending on your situation, you might consider reinvesting some or all of your RMDs in a mutual fund or an annuity to ensure your retirement income strategy works the way you planned.

• A mutual fund may be appropriate if you like the potential of continued growth and want to explore investment options.
• An annuity is an option if you want potential earnings to grow tax-deferred and to provide for your heirs.

You may also delay taking RMDs on a portion of your retirement assets by transferring them to a qualified longevity annuity contract (QLAC). The SECURE Act 2.0 allows you to invest up to $200,000 in a QLAC, protecting those funds from RMDs while helping to increase income payments from the annuity. Then when you reach 85, you must take distributions.

If paying taxes on your RMDs throughout retirement is a concern, you might consider completing a Roth IRA conversion.² Roth IRA conversions have several advantages, including:

• Diversifying your investment portfolio
• Alleviating concerns of future tax rates
• Maintaining your current tax bracket
• Avoiding RMDs

The downside is your taxable income the year of the conversion will rise, and you will have to wait at least five years to withdraw the earnings on a tax-free basis. Additionally, you must satisfy your current year’s RMD requirement prior to the conversion.

A Roth conversion may be appropriate if you:

• Won’t need the RMD income during your lifetime.
• Seek the potential for continued tax-deferred growth.
• Are in a lower tax bracket now compared to what you think you’ll be in at age 72.
• Believe your heirs will be in a higher tax bracket when they inherit these funds than the tax bracket you’re in now.
  

> Read about the pros and cons of Roth IRA conversions for more detailed information.

As college costs climb, students rely more on financial help from grandparents and parents. If you don't need RMDs for your retirement expenses, you may effectively reduce the size of your estate by using them to fund a tax-advantaged college savings account.

Thanks to the SECURE Act 2.0, you may roll over a lifetime cap of $35,000 from a 529 plan to a Roth IRA in the student beneficiary's name, starting in 2024. However, the 529 account must meet certain rules, including being at least 15 years old. Rollovers will be subject to the annual Roth IRA contribution limit of $6,500 for those under age 50; $7,500 those age 50 or older.

Another RMD strategy can help you create a legacy beyond your lifetime for the benefit of your loved ones. If you’re healthy and don’t need RMDs for living expenses, you could use the after-tax portion to fund a life insurance policy. The death benefit of the life insurance could eventually be used to pay the taxes due on the IRA, leaving the full remaining value of the IRA for your loved ones.

Alternatively, if you could name a charity as the beneficiary of your life insurance contract, proceeds from the contract could support this cause after you pass away.

Supporting charity is an essential value for many. So you can use the deduction from donating your RMD to offset your tax liability while still doing good for causes that matter.

A qualified charitable distribution (QCD) can help you meet your RMD requirement while providing charitable intent and potential tax benefits.

Here's what to know:

• Individuals over 70½ can give up to $100,000 (adjusted for inflation yearly) from a traditional or inherited traditional IRA tax-free.
• People age 70½ and older can give a one-time gift of up to $50,000.
• Gifts can go to a charitable remainder unitrust (CRUT), charitable remainder annuity trust (CRAT) or charitable gift annuity (CGA).
• For the gift to count, it must come from your IRA by Dec. 31.

IRS regulations make it possible to delay taking RMDs on a portion of your retirement plan assets until you reach age 85 by transferring them into a qualified longevity annuity contract (QLAC). By doing so, you’ll receive higher guaranteed income payments and your retirement assets will last longer. The caveat, of course, is anticipating how long you’ll live. However, QLACs give you the ability to name a beneficiary, who would receive the assets after you die.

As you consider all the options for your retirement accounts, your financial advisor can help you figure out your annual required minimum distributions and decide which approach is right for you.