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Making the Most of Required Minimum Distributions

| August 08, 2019
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If you’re approaching age 70 1/2, prepare to start taking required minimum distributions (RMDs) from your tax-deferred retirement accounts. Qualified tax-deferred accounts include IRAs, SEP-IRAs, Simple IRAs, 401(k)s, and other types of employer-sponsored retirement plans. An exception is a Roth IRA, which is not subject to RMD rules during the original owner’s lifetime.

To clarify, you can make withdrawals from these retirement accounts before you turn 70 1/2. Any withdrawals, at any age, will be taxed as regular income. There are a few rules associated with these withdrawals that you’ll want to keep in mind:

  • Withdrawals before age 59 1/2 may be subject to a 10% federal penalty fee as well as a possible state fee. Depending on your unique circumstances, this penalty fee may be avoided if you’re using the withdrawal for a few different reasons including educational expenses, a first-time home purchase, or if you’re disabled.
  • Once you reach age 59 1/2, you can make optional withdrawals from retirement accounts without restrictions or fees.
  • When you reach 70 1/2, RMDs kick in. They’re mandatory, and if you don’t make withdrawals, you'll have to pay a hefty 50% penalty fee on the amount you were supposed to withdraw. These withdrawals are generally a percentage of the previous year-end balance. Once the distribution is taken, it cannot remain in a tax-deferred retirement account.

We get it: you might not want to take money from accounts you’ve worked years to build. But the fact of the matter is, because they’re required withdrawals, you may as well put them to good use. If you don’t need the extra money to cover bills or other necessities, consider these five smart uses for your RMDs.

Invest in a Non-Qualified Account That Gets Stepped-Up in Basis When Inherited

If you’re passing assets on as inheritance, it could benefit from additional investment. That’s because the stepped-up cost basis is often more valuable than the initial cost basis – essentially, the stepped-up value is the asset’s market value at the time the benefactor (you) passes away. A high stepped-up basis can reduce the beneficiary’s taxable capital-gain income when he or she eventually sells the inherited asset.

Put RMDs Toward Life Insurance Premiums

You can put RMDs toward life insurance premiums to immediately increase the inheritance your heirs will receive. Life insurance plans have contribution limits based on age, health rating, and face amount.  Knowing that your loved ones can benefit from the additional (tax-free) money could bring peace-of-mind. In addition, some forms of life insurance can provide supplemental income during retirement. Most plans offer tax-free loans.

Invest in Future Generations

For some families, giving the gift of education is a great honor. If you have grandchildren or other college-aged loved ones, you may decide to use your RMDs to fund their education. Many 529 college savings plans make it easy to “gift” funds – and your contribution could be state tax deductible.

Give Back to the Community

Money from RMDs can also be donated to charity. The qualified charitable distribution (QCD) allows those 70 ½ or older with IRAs to transfer up to $100,000 to an eligible charity. This amount can replace your RMD and may be excluded from taxable income. While other types of retirement accounts and employer-sponsored accounts are not qualified for QCDs, charity can still be a good way to use RMDs – whether it’s animal welfare, the environment or helping the less-fortunate, you can support a cause you care about.

Have Some Fun

Some investors see retirement as the ideal time in life to pursue a passion or travel. You may choose to use your RMD to fund a family vacation, splurge on a new pool, revamp a kitchen or even pay for art classes at the local community college. That’s the great thing about RMDs – you can use the after-tax money however you’d like.

Wondering how to spend your hard-earned money – and overwhelmed by the possibilities? Meeting with a financial advisor can help you decide how to use your RMDs effectively. If you need more specific information about retirement accounts, you can find a more detailed breakdown of each type of retirement account here.

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