What to Do With RMDs You Don’t Need?

Required Minimum Distributions (RMDs) are specific amounts that individuals must withdraw annually from most employer-sponsored retirement plans and traditional Individual Retirement Accounts (IRAs) once they reach a certain age. These withdrawals are mandated by tax regulations to ensure that taxes are eventually paid on pre-tax contributions and earnings that have grown tax-deferred over time. Many individuals find they do not need these funds for immediate living expenses. This presents an opportunity to strategically manage surplus distributions for tax efficiencies and long-term financial benefits.

Qualified Charitable Distributions

A Qualified Charitable Distribution (QCD) offers a strategic way to satisfy a Required Minimum Distribution (RMD) while supporting a chosen charity. A QCD involves a direct transfer of funds from an Individual Retirement Account (IRA) to a qualified charitable organization. This direct transfer allows the amount to be excluded from the individual’s taxable income, which can be particularly advantageous for those who do not need the RMD for living expenses.

To be eligible for a QCD, an individual must be at least 70½ years old at the time of the distribution, even though the RMD age is now 73. The distribution must go directly from the IRA custodian to the charity; funds should not pass through the individual’s hands. This direct transfer is necessary for the distribution to qualify as non-taxable.

The annual limit for QCDs is $105,000 per individual for the 2024 tax year, increasing to $108,000 for 2025, and this limit is adjusted annually for inflation. A QCD can satisfy all or part of an individual’s RMD for the year. Using a QCD can reduce taxable income, which may help avoid higher income tax brackets or the phase-out of certain tax deductions.

This strategy is especially useful for those who do not itemize their deductions, as the tax benefit comes from the exclusion from income rather than a deduction. QCDs cannot be made from employer-sponsored retirement plans like 401(k)s, but they are permissible from traditional IRAs, inherited IRAs, and inactive SEP or SIMPLE IRAs.

Reinvesting Your RMD Funds

When an individual takes a Required Minimum Distribution but does not need the cash for immediate expenses, a common approach is to reinvest the funds. This strategy applies to money after it has been distributed from the retirement account and included in taxable income. The focus then shifts to where to place these after-tax dollars to continue growth or generate additional income.

Taxable brokerage accounts are a primary destination for reinvested RMD funds. These accounts allow for the purchase of a wide range of investment products, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Unlike retirement accounts, taxable brokerage accounts do not have contribution limits or specific withdrawal rules based on age, meaning individuals can access funds at any time without early withdrawal penalties.

Investments held within these accounts are subject to taxation on earnings. Dividends or interest generated are taxed annually as ordinary income. When investments are sold for a profit, capital gains taxes apply. The tax rate depends on how long the investment was held: short-term gains (one year or less) are taxed at ordinary income rates, while long-term gains (more than one year) are taxed at lower, preferential rates. Strategic decisions about asset location, such as holding tax-efficient investments like municipal bonds or certain index funds in taxable accounts, can help manage the tax impact.

Coordinating RMDs with Roth Conversions

A common misconception is that a Required Minimum Distribution (RMD) can be directly converted into a Roth IRA. Tax regulations clarify an RMD cannot be directly converted; it must first be taken as a taxable distribution from the traditional retirement account. Once the RMD is satisfied for the year, any additional funds from the traditional IRA can then be considered for a Roth conversion.

Roth conversions involve moving pre-tax money from a traditional IRA or 401(k) into a Roth IRA. This process is a taxable event, meaning the converted amount is added to gross income for that tax year and taxed at ordinary income rates. This increase in taxable income can potentially push an individual into a higher tax bracket. The RMD itself already adds to taxable income, so individuals often consider the combined impact of the RMD and a Roth conversion on their overall tax liability.

Individuals might use the cash received from their RMD to pay taxes associated with a Roth conversion of other pre-tax retirement funds. This approach allows converted funds to grow tax-free within the Roth IRA and be withdrawn tax-free in retirement, as Roth IRAs do not have RMDs for the original owner. Planning Roth conversions over several years, especially during periods of lower income, can help manage the tax impact and potentially reduce future RMDs by decreasing pre-tax account balances. This can also influence other income-based considerations, such as Medicare premiums, which are tied to Modified Adjusted Gross Income (MAGI).