The U.S. tax code requires those age 70½ to take annual withdrawals from an IRA, 401(k), SEP IRA or similar type of retirement savings account. These required minimum distributions (RMDs) can create a quandary for those who are forced to take the distributions, but do not need the money. Christine Benz of Morningstar has three suggestions on what retirees in this situation can do with the unwanted cash.
1. Contribute to a Roth IRA: Roth IRAs are exempt from the RMD rules. Retirees can contribute new dollars to them if they or their spouse have enough income from working to cover the amount contributed to the Roth IRA. Retirees who do not have earned income cannot contribute new dollars to a Roth IRA, but can do a Roth IRA conversion provided the RMD requirements for the current calendar year are met.
2. Deposit Into a Taxable Investment Account: Those without earned income can deposit the excess RMD dollars into taxable account, such as a traditional brokerage account. If the money is not needed for a long time (e.g., intended for an heir), some type of equity investment could make sense. Those with shorter investment horizons and who are in a high enough tax bracket could consider municipal bonds or tax-managed funds.
3. Allocate to a 529 Plan: Retirees who plan to take college courses in the future can use a 529 plan to set dollars aside and allow those dollars to grow tax-free. There may also be a state tax benefit to doing so. The money must be used to pay for qualified educational expenses, however.
4. Make a Charitable Contribution: Those age 70½ or older can donate up to $100,000 directly from their IRA to a qualified charity. These qualified charitable donations (QCD) reduce the current year’s RMD dollar-for-dollar up to $100,000 per year. As such, they also reduce the amount of taxable income for the calendar year. Benz adds that waiting until late in the year to make the QCD allows the retiree to take advantage of compounded returns realized throughout the year.
Source: “What to Do With Unneeded RMDs,” Christine Benz, Morningstar, January 10, 2017.
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