Exploring Strategic Methods to Manage Your Mandatory Minimum Distributions (MMDs) During This Period
As the year's end approaches, many elderly investors will likely withdraw substantial sums from their retirement accounts like IRAs and 401(k)s. Particularly for those who have delayed initial withdrawals as long as possible. Although you don't have to draw your first required minimum distribution (RMD) from most tax-deferred accounts until April 1 of the year following your 72nd birthday, after that, annual withdrawals must be made by December 31. Consequently, if you choose to delay that first distribution until your 73rd year, you'll be required to make two withdrawals that year.
In 2023, a 73-year-old's initial RMD would amount to approximately 3.7% of the account's value as of the preceding year's end. Surprisingly, this percentage increases gradually each subsequent year.
This requirement raises a critical question for many senior investors: What should you do with the funds you are compelled to withdraw from your retirement accounts if your financial requirements do not necessitate these disbursements? Here are five potential solutions.
1. Contribute to an IRA, if eligible
This may appear counterintuitive when you're forced to withdraw money from retirement accounts; but, presuming your eligibility, you can utilize these RMD funds to fund IRA contributions for the tax year in which you drew the funds.
The primary condition for eligibility is earning income through employment. In 2023, anyone aged 50 or above is allowed to contribute the lesser of $8,000 or 100% of their income generated from work into either a traditional or Roth IRA, depending on their income level. Notably, the IRS disregards the source of funds for this contribution. Consequently, reaching the age at which you must begin required minimum distributions does not negate your eligibility to participate in an employer-sponsored plan like a 401(k), provided you are still employed by a company that offers one.
Nevertheless, depositing fresh funds into a non-Roth IRA will cause your future RMDs to increase. Furthermore, while IRA contributions may be tax-deductible, required minimum distributions are also considered taxable income.
If you wish to maintain as much capital as possible in a tax-deferred account, this option may be advantageous.
2. Finance a Roth conversion's tax bill
If you wish to eliminate RMD requirements completely, you can choose to convert your traditional IRA into a Roth IRA, as Roths are exempt from required minimum distributions.
This move is usually 100% taxable, meaning the entire balance you convert will be regarded as income during the year of conversion. While you can use some of the converted funds to defray the tax bill, this will significantly decrease your balance. Additionally, the conversion does not negate RMD requirements for any previous years.
By utilizing strategic timing, however, you can fulfill your preceding year's RMD requirement while offsetting at least a portion of the tax expense associated with converting your IRA to a Roth.
Furthermore, it is more advantageous to carry out Roth conversions during a market downturn as this will minimize the tax bill.
3. Park in a money market fund
If none of the previous options suit your needs, there are other tax-efficient alternatives for using your RMD funds. One such alternative is simply depositing the funds in a secure yet profitable vehicle like a high-yield money market account.
Although rates offered by typical checking and savings accounts remain disappointing, you should invest this money into a true money market mutual fund, which are currently offering yields between 4% and 5%.
While some money market funds have minimum holding periods and require the sale of shares to access your money, the higher yields make them an appealing option.
4. Invest according to your portfolio's objectives
If you have the financial means to do so, you could reinvest your RMD funds in a manner that contributes to your overall portfolio's objectives. This may involve purchasing dividend stocks or growth stocks, depending on your objectives.
It is essential to remember that this money is no longer in a tax-deferred account, while a significant portion of your retirement savings will remain in an IRA. In such a case, investing in dividend stocks for income purposes may as well be done in a taxable brokerage account, as the dividend income will still be liable to taxation.
5. Give the funds away (tax-efficiently)
Lastly, if you have no current need for the RMD funds and are confident that you will never require them in the future, consider dedicating the funds to charitable contributions.
Certainly, when it comes to funds you have, whether it's charitable donations or not, you should aim to make the most of tax efficiency. Designating a required minimum distribution as a qualified charitable distribution is an excellent way to achieve this. In simple terms, this means directly transferring cash or assets to legitimate charitable organizations, before they even reach your hands or get listed outside of a retirement account.
At first glance, this direct transfer process might seem unnecessary. After all, required minimum distributions are taxed as income, but charitable donations can be deducted from taxes.
However, there's a key difference. You need to itemize to claim regular donations as charitable deductions. On the other hand, a qualified charitable distribution (QCD) functions as a deduction without the need for itemization by reducing what would normally be taxable income. Moreover, for the vast majority of individual filers, there are relatively minimal annual limits for tax deductions derived from charitable gifts in cash or assets under your name. Conversely, qualified charitable distributions can be utilized to meet the IRS's minimum distribution requirements, sans ever appearing in your name, thereby not increasing your taxable income in a particular year. This year's QCD cap stands at $105,000 per person or a combined $210,000 for joint filers.
In the context of managing funds from required minimum distributions (RMDs), some senior investors may want to consider converting their traditional IRAs into Roth IRAs to eliminate RMD requirements entirely. This move is usually 100% taxable, but strategic timing can help offset the tax expense associated with the conversion.
Additionally, for individuals who have delayed initial withdrawals as long as possible, they should be aware that a portion of their retirement income may be subject to taxes during retirement. Properly managing these funds can help minimize tax obligations, which is crucial for maintaining as much capital as possible in a tax-deferred account.
%20During%20This%20Period){kind=link}