What’s the best way to take your required minimum distribution (RMD)?
Should you withdraw it all at once or in installments? And what should you do with the money?
These are some of the questions you’ll want to consider periodically as your life and circumstances change. Maybe you usually reinvest your RMD in a taxable account, but this year, you’ve got a home renovation coming up or a big family trip planned, so you’re going to take your RMD in cash to cover these additional costs.
We’ve been managing RMDs for our clients for decades, and this time of year, we’re busy helping clients figure out the right RMD approach for them. Here are some tips and answers to common questions that can help you find an approach that works for you.
Even if you’ve already taken your RMD for this year, these tips can help you think through what to do with the proceeds or consider what you might do differently in the future.
A quick RMD refresher
You probably know that when you turn 70½, the IRS requires that you withdraw a minimum amount from your tax-deferred IRA each year in what’s called a required minimum distribution, or RMD. (You don’t have to take RMDs from a ROTH IRA.)
If you don’t take your RMD, or you take less than required, you’ll face a steep penalty of 50% of the amount you should have withdrawn.
RMD Tips & FAQs
Should I take my RMD in one lump sum or in installments? Early in the year or later?
It depends on whether you need the cash now or not. If you need the cash, you’ll probably want to take your RMD in installments. You can set up a monthly or quarterly withdrawal through your broker or custodian. You’ll also need to make sure the cash is available each month or quarter to accommodate the withdrawal.
If you don’t need the cash now, consider taking your RMD in one lump sum later in the year. This gives you time for extra tax-deferred growth in your account, since the market is often (though not always!) higher at the end of a year than at the start.
How should I raise the cash for the withdrawal?
It’s wise to set aside two or more months worth of withdrawals in cash and replenish that amount throughout the year. You can raise cash by selling off shares of funds in your account.
At FundX, we use our active investment approach to raise cash for clients' RMDs. When we sell a fund, we can set aside part of the proceeds for a client's RMD and then invest the rest in an appropriate fund. This means that the clients portfolio might be holding less of a fund, but this is often easier than selling off shares of several funds on a pro-rata basis, and it helps avoid transaction costs, too.
What should I do with my RMD? Can I reinvest my RMD?
Just because the IRS requires you to take the money out of your IRA each year does not mean you are required to spend it. If you don’t need the money now, you can reinvest it in a taxable account—that’s what we do for many of our clients. We’ll move the money from the client’s IRA and into a taxable investment account, often one that is managed in a very similar, yet tax-efficient way, and reinvest the RMD.
If you need some money now to cover your expenses, you can keep some of your RMD in cash and then invest the rest.
Can I donate my RMD to charity?
Yes. You can donate as much as $100,000 of your RMD to charity. This gives you the chance to support worthy organizations, and you also won’t have to pay income tax on a qualified charitable distributions. Many of our clients use their RMD to give to important causes.
What if I have more than one IRA?
If you have a traditional IRA and a rollover IRA, for instance (or a SEP-IRA or SIMPLE IRA), each account will have its own separate RMD, but you can bundle the RMD amounts together and then withdraw the total from one of your IRAs.
There are some limitations, however: You can’t bundle RMDs from inherited IRAs. And you also can’t aggregate your RMDs from your IRA with your RMD from your 401(k) account.
What about taxes?
Each dollar taken from an IRA is taxable as ordinary income. You may choose to have your custodian withhold federal taxes from each distribution and send it on to the IRS on your behalf. Some custodians will do this for state tax withholding as well. Check with yours to find out. This may not be necessary if you are paying quarterly estimated tax payments. Check with your tax advisor.