Saving for retirement in a tax-deferred account — such as a 401(k) or traditional IRA — can be a smart way to minimize taxes while you’re working. Your initial contributions are tax-deductible, and you’ll only owe income taxes once you start making withdrawals.
Because Uncle Sam wants those taxes sooner rather than later, though, you’ll need to start taking required minimum distributions (RMDs) by age 73 — even if you’re still working or don’t need your savings just yet.
Not taking your RMD by the end of the year could be costly, as the IRS may impose a 25% penalty on the amount you didn’t withdraw. The good news is that rather than simply withdrawing your money and letting it sit in a checking account, you can reinvest your RMDs to continue earning returns on your investments. But there are a few important things you’ll need to know first.
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1. You can only invest in certain accounts
If you’re reinvesting your RMD, you can’t put that money back into a tax-deferred account like a 401(k) or traditional IRA. In some cases, you can invest it in a Roth IRA (which is not subject to RMDs), but there are some tricky caveats.
Technically, when contributing to a Roth IRA, you can only invest earned income — such as a salary or wages from contract work. If you’re retired and living off a pension or other passive income streams, this will likely disqualify you from reinvesting your RMDs into this type of account.
However, if you’re still working, you could take your RMD but then invest the same amount of earned income into a Roth IRA. Keep in mind that this is different from a Roth conversion, which is strictly prohibited by the IRS.
Perhaps the simplest approach is to reinvest your RMD into a taxable investment account. There are no age requirements for this type of account, so you can leave your savings there for as long as you’d like until you’re ready to withdraw.
2. Consider taking in-kind distributions
In some cases, you may choose to withdraw your RMDs and then manually reinvest the money elsewhere. But if you want to transfer your RMD directly to a different account, you can make in-kind distributions.
With an in-kind distribution, your financial institution can transfer your RMD from your retirement account to a taxable investment account without you having to withdraw the cash first. Not only can this simplify the process for you, but it will also keep your money invested.
If you withdraw your savings and then reinvest it later, you’ll miss out on at least one market day. While that may not be the end of the world for your investments, it could hinder your earnings. If you’re able to take in-kind distributions, you can ensure you’re maximizing your money’s potential.
3. Be mindful of your asset allocation
If you’re reinvesting your RMDs into a taxable brokerage account, you’ll likely have many more investment options than with a retirement account such as a 401(k). That can be a good thing, as it will give you more control over your financial future. But if you invest too aggressively, it could spell trouble for your retirement.
Your asset allocation refers to how your money is divided between higher-risk investments (like stocks) and lower-risk investments (like bonds). While everyone’s preferences are different, in general, older adults should lean more toward conservative investments to protect against market volatility.
If your asset allocation is on the aggressive side, your portfolio may take a significant hit during periods of volatility. This isn’t necessarily a bad thing, as long as you can give your savings several years to recover. But if you expect to withdraw this money in the next year or two, investing too aggressively could put your retirement at risk.
Reinvesting your RMD can be a smart way to maximize your earnings and strengthen your nest egg, but the right strategy is key. The more prepared you are now, the better off you’ll be down the road.
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