What To Do With RMDs If You Don't Need Them?
Understanding the strategic management of RMDs, if they're not needed immediately, is one way of enhancing financial well-being and minimizing taxes. And there are several prudent ways to use these funds, such as reallocating them towards other savings, donating to charities, or investing in a family member’s future.
At Cooke Wealth Management (CWM), we recognize the pivotal role of Required Minimum Distributions (RMDs) in comprehensive financial planning. As an independent firm managing over $100 million for more than 100 families, we're dedicated to crafting custom investment plans and delivering personalized financial coaching. Our goal is to empower our clients to make well-informed decisions about their retirement funds and beyond.
At CWM, we believe that professional guidance is key to effectively using RMDs—whether for investing, planning for retirement, or supporting family needs. However, before taking any action , it’s important to thoroughly understand everything about them, especially if you don’t need RMDs. And that’s what this article is for!
Understanding RMDs
RMDs are minimum amounts that the law mandates individuals must withdraw annually from their traditional, SEP, or SIMPLE IRAs and retirement plan accounts once they reach a certain age. Initially, this age was set at 70 ½, but recent changes navigated by the SECURE Act 2.0 have increased this to 73 for individuals born between Jan 1, 1951 and Dec 31, 1959 and 75 for those born during or after 1960.
RMDs were set up to ensure government tax collection because funds in these retirement accounts grow through tax-deferred compound interest, and therefore taxes are not paid until withdrawal. This means once the RMDs commence , it can potentially push you into a higher tax bracket, causing an increase in overall tax liabilities.
The concept behind RMDs is that over time, retirement savings that have grown tax-deferred throughout one’s career should eventually become subject to taxation. However, it's crucial to remember that the timing and amount of these distributions will influence how much tax you end up paying.
With the new regulations and age requirements, it is important to calculate your RMDs correctly. Mistakes could subject you to a stiff penalty of 50% of the amount that should have been withdrawn. Therefore, understanding your RMDs, their implications, and recent changes are an important part of retirement planning.
Using RMDs Strategically: 5 Options You Have
1. Qualified Charitable Distributions (QCDs)
If you are fortunate enough not to rely on RMDs for your daily expenses, you can consider redirecting this money to a good cause. Beneficially, a Qualified Charitable Distribution (QCD) allows you to donate your RMD directly to a qualified charity, tax-free. Donating RMDs as QCDs helps you fulfill your philanthropic desires, possibly reduces your taxable income, and satisfies the RMD for the year.You won’t have to declare the RMD as income, but at the same time you do not get to claim the charitable deduction.
2. Roth IRA Conversions
Another strategic maneuver that could prove beneficial, especially in the long run, is converting all or some of your IRA into a Roth IRA. Although this means you'll pay taxes on the amount transferred upfront, the money within the Roth IRA will then grow tax-free and, more importantly, withdrawals in the future will also be tax-free. In addition there is never a RMD for the amount in your Roth IRA. As a note you must first take any RMD required before converting other IRA money to a Roth. You can convert the RMD. This strategy requires careful planning, but it may safeguard you from higher tax brackets in the future.
3. Investment Reentrance
RMDs can be reinvested, both in traditional ways like stocks, bonds, or real estate or into promising start-ups or other innovative investment opportunities. It's a way of going beyond the conservative approach typical of retirement funds. By reinvesting RMDs, you can potentially earn more and grow your wealth, even comfortably retired. You will have to pay tax on the RMD, but the net amount can then be invested for the long haul. Once invested outside of an IRA you only pay tax on the gain and capital gain taxes are much lower than regular taxes.
4. Family Financial Support
It's possible to divert your RMDs for the financial welfare of those you care about. This could range from setting up college funds for the grandkids, supporting family members facing financial challenges or simply investing in your family's future by planning for generational wealth transfer. By doing so, you can ensure your RMDs create a lasting legacy for your loved ones.
5. Tax Planning And Simulation
Proper planning can make all the difference when dealing with the tax implications of RMDs. Tax simulation tools and strategies help you understand future tax burdens and the effects of various disbursement options on your tax liabilities.
For instance, spreading RMDs out over time or bunching them in certain years can help manage taxable income and potentially lower tax brackets. Consulting a tax advisor or financial planner can provide personalized plans and predictions based on your unique circumstances.
Practical Steps To Take
Let's break down the practical steps involved in implementing each strategy mentioned above.
When considering Qualified Charitable Distributions (QCDs), the first port of call is to identify a cause that resonates with you, one you believe will benefit from your financial support. You should then contact your IRA administrator and instruct them to transfer funds directly to the charity. Remember this must be a direct transfer to qualify as a QCD. You'll also need to consider the amount you wish to donate, bearing in mind that QCDs can only cover up to $105,000 a year in 2024. The maximum you can give as a QCD will increase each year indexed to inflation.
If a Roth conversion is more your speed, the process begins by opening a Roth IRA account if you don't already have one. Then, make sure you have already withdrawn your RMD either directly or by way of a QCD. You then initiate the conversion with your traditional IRA provider, specifying how much you want to transfer to the Roth IRA as the conversion. Remember, this amount will be added to your taxable income for the year. Also consider the tax implications; you may want to spread out your conversions over several years to avoid a sudden spike in income that could push you into a higher tax bracket.
In the case of reinvestment, the path forward is relatively straightforward. In this scenario, you're going to take the RMD and place it back into the market either via a taxable brokerage account, real estate, or another investment venture. For this, you may want to consult with a financial advisor to understand the potentially complex tax and timing considerations that come with investing RMDs.
As for providing family financial support, the first element to map out is whom you plan to support: grandchildren, children, or maybe a sibling. Once you've determined the beneficiary, you can then structure an appropriate gift using your RMDs. This can be a direct gift, contribution to a 529 college savings plan, or perhaps through a trust. Be sure to consider potential pitfalls like the gift tax or any implications on the beneficiary's tax situation.
Finally, when tackling tax planning and simulation, the best first step is to consult with a tax professional or financial advisor. They will be able to guide you through different scenarios, helping you understand the tax implications of your RMDs. Financial advisors can also help you tailor strategies to meet your personal financial circumstances and goals. This could involve anything from adjusting the timing of your distributions to factoring in additional deductions or credits.
All these practical steps underline the importance of strategic planning when deciding what to do with RMDs if they’re not needed. By having a clear process in place, you can focus your RMDs to provide optimal financial benefit.
Using CWM Services To Leverage RMD Benefits
Managing finances, especially RMDs, can be overwhelming. The complexities of tax laws, investment options, and financial strategies require detailed knowledge and constant attention. Individuals often find it challenging to optimize their financial plans for growth, tax benefits, or family support on their own.
Cooke Wealth Management (CWM) provides a solution to this challenge. Based in Orange County, we offer personalized financial coaching and investment management. Our services include custom investment plans, retirement strategies, and college funding solutions, all designed to help clients achieve their financial goals.
For those seeking to strategically manage their RMDs or enhance their overall financial planning, Cooke Wealth Management is ready to assist. Schedule a discovery session today to explore how CWM’s expertise can help you navigate financial complexities, ensuring your wealth serves your most important goals effectively.
Frequently Asked Questions (FAQ)
1. What can you do with RMDs if you don't immediately need them for living expenses?
In addition to the strategies mentioned above, you could allocate the after-tax portion of your RMDs into a life insurance policy. This strategy may allow the life insurance death benefit to cover the taxes on your IRA, thereby preserving the IRA's full value for your heirs, addressing concerns about what to do with RMD if not needed.
2. Is it possible to reinvest your Required Minimum Distributions (RMDs)?
While you cannot reinvest RMDs directly into most retirement accounts, you can place them into a taxable investment account. Other options include using RMDs for tax-advantaged purposes like funding 529 education plans or donating to qualified charities.
3. What penalties exist for not taking Required Minimum Distributions?
Not withdrawing the full RMD amount prior to 2023 incurred a 50% excise tax on the undistributed amount. However, the SECURE 2.0 Act reduced this to 25%, and further to 10% if corrected within two years, beginning in 2023 and beyond, highlighting the importance of timely RMD withdrawals.
4. How can you manage your RMDs when you don't need the money?
Managing unneeded RMDs can involve tax-saving strategies like in-kind transfers, redistributing for safe or general growth, and considering a Qualified Charitable Deduction, each offering different benefits for those looking for efficient ways to handle their RMDs.
5. Can you invest RMDs into a Roth IRA?
The IRS prohibits reinvesting RMDs directly into a Roth IRA or any other retirement account. . However, this doesn't mean the end of investing opportunities.. Once you have completed your RMD any or all of the remaining funds in an IRA could then be converted to a Roth IRA.