Many retirees who were strong savers throughout their careers reach retirement and are pleasantly surprised by how little of their nest eggs they really need to make ends meet. Between their costs falling in retirement and income from Social Security and their after tax portfolios, some even discover that they don’t even need to spend their required minimum distributions (RMDs).
Yet regardless of whether you need to spend that money, once you reach age 72, those RMDs mean you must take money out of most qualified retirement plans. Although you can’t roll those required distributions into another retirement account, you can still make smart use of that money, even if you don’t need to spend it. These three approaches offer great strategies on what to do if you don’t need your RMD.
No. 1: Give it directly to charity
Once you reach age 70 and a half, you can make what’s known as a qualified charitable distribution. With that approach, you can donate up to $100,000 per year to a charity directly from your Traditional IRA. If made before you take your RMD for the year, the donation can count against the total you need to take as your RMD.
In addition to reducing the need to take the RMD, the qualified charitable distribution never counts as income for a retiree. This can help retirees reduce the higher taxes and mandatory costs that RMDs would otherwise drive.
A key watch out, though, is that you can run into trouble if you make a Traditional IRA contribution and a qualified charitable distribution in the same year. In essence, the qualified part of your charitable distribution reduces by the amount of your Traditional IRA contribution. That can reduce the net tax benefit of the plan, but it is still generally a good deal.
No. 2: Invest it in after-tax accounts
Although you must take the Required Minimum Distribution from your retirement accounts, there is no rule that says you have to spend the money once you take it out. After you pay your taxes on the distribution, the cash you take out can be invested in an ordinary brokerage account with no issues attached.
Even if you don’t directly need the money, investing it this way can be an important estate planning tool. Investments transferred as inheritance get a step-up in basis based on the date the original owner died. In essence, if you buy $10,000 of stock in an after-tax account that grows to be worth $50,000 when you pass away, your heirs receive that stock as if they paid $50,000 for it.
In addition, money you have invested in after-tax accounts remains available to you throughout your life. If you find you need the money, you can tap it to spend. If you decide you want to take your extended family on a major bucket list vacation, you can use it.
No. 3: Use it to pay the taxes on Roth IRA conversions
You must take your Required Minimum Distributions before you make any Roth IRA conversions with your money. Still, once those distributions have been taken, you can convert any additional amount you want from your Traditional IRA to your Roth IRA. Those conversions are taxable events. Using the money you are required to take out of your other retirement accounts to cover the taxes on your Roth IRA conversion can help you out in several ways.
First, once your money is inside your Roth IRA, it is never again subject to a required distribution within your lifetime. Those required distributions can get quite large later in life, as the percentage of your account balance subject to them increases as you age. By converting more of your Traditional retirement account balance to a Roth IRA earlier in your retirement, it can keep those later-life distributions down.
Next, once you have money inside a Roth IRA for at least five years and are past age 59 and a half, you can take distributions from your Roth IRA completely tax free at any time for any reason. That offers an unparalleled level of flexibility on how you spend your money, should you eventually need or want to tap it.
In addition, after you pass away, your heirs can typically take withdrawals from an inherited Roth IRA completely tax free as long as the account has been open at least five years. Note that your heirs generally must empty the inherited Roth IRA within 10 years, although there are some exceptions for cases like spouses that are the sole beneficiary of the Roth IRA account.
Use these approaches to manage your retirement nest egg effectively
If you’re in a spot where you don’t need your RMDs to make ends meet in retirement, then overall, you’re doing just fine. Congratulations on having a great foundation in place. Consider these approaches as the icing sweetener on an already finely baked cake.
Still, remember that to use these approaches effectively, it helps to plan ahead. In some cases, the order of how you tackle things matters to assure your success. In addition, paying attention to the tax years involved and your age at the time will help make sure you always stay on the right side of the rules associated with RMDs. So build your plan now, and improve your ability to effectively manage your retirement nest egg in line with your personal priorities.
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