Retirement accounts help you save for your future, manage your taxable income and shelter your investment earnings from taxes—at least temporarily. But the IRS doesn't allow you to protect your hard-earned savings from taxation indefinitely. Instead, you must withdraw funds from most qualified retirement accounts at a certain point due to required minimum distribution (RMD) rules.
When you withdraw those funds, you generally owe taxes on them, but why? Is a RMD considered earned income? How is that possible when you're being "forced" to take the withdrawal? And what can you do with the funds if you don't need the money?
How do RMDs work?
Ultimately, RMDs are designed to draw down all of your assets over your remaining lifespan, so it's typically based on your account balances at the end of the previous year, and your age in the current year. The IRS
RMDs typically begin at age 72 and hover just below 4% of your year-end account balance—but that percentage grows over time. So, if you had $100,000 on December 31 of the previous year, your RMD might be roughly $3,650 (assuming you use the
Note that the age to begin receiving RMDs used to be 70½. But that
Are RMDs considered earned income?
In short, no—neither a RMD nor any other distribution plan is considered earned income. However, the IRS treats RMDs as ordinary and therefore, taxable income.
As mentioned, the point of RMDs is to remove funds from tax-protected accounts. And in many cases, you didn't pay federal income tax on that money, so RMDs force you to report the income you previously deferred. Ultimately, RMDs generate revenue for the U.S. Treasury.
What if you fail to take an RMD?
The IRS imposes steep penalties for missing an RMD, so it's critical to take them each year. The penalty is 50% of the amount you were supposed to withdraw. That is an unnecessary cost that can take a big bite out of your retirement savings, so consider ways to avoid that penalty. For example, you might be able to automate RMDs, or you can set up reminders on your calendar every year. No matter what approach you take, be sure you're on top of these withdrawals.
What if you don't "need" the money from required minimum distributions?
Bear in mind that just because you are required to withdraw money from your retirement plan, you don't have to spend it. If you feel stable in managing your day-to-day retirement finances, here are some other savvy uses for your RMD.
1. Reinvest it. You don't have to stop investing just because you take an RMD. You could consider moving your RMD directly from your retirement account to a taxable
2. Pass it along. If you're planning to help someone
3. Donate to charity. You can complete a
Ultimately, you have various ways to put your RMD money to work if you don't need the funds for everyday living expenses. But each option has pros and cons, and the tax rules are complicated. To minimize problems, work closely with a tax professional who is familiar with your situation.
The bottom line
RMDs are a fact of life when you save for retirement in pretax accounts. Like birthday cake, the IRS doesn't want you to have too much of a good thing, so eventually, you need to pay taxes that you previously avoided. You simply can't avoid RMDs, and if you don't need the money, shifting funds is a matter of strategy and logistics.
It's wise to execute any changes with professional help, though, so