Can I Reinvest My Required Minimum Distribution?

Key Takeaways

With most retirement accounts, you must take an annual required minimum distribution (RMD) once you reach a certain age. This means you take a payout from your traditional IRA, 401(k) or other retirement account. The required amount is calculated based on your age and the account balance. Occasionally, laws change RMD guidelines, and it’s important to stay on top of the rules.

But what can you do with the RMD money if you don’t need it right away? If a pension or other income has already got your expenses covered for the year, you may be scratching your head over what to do with the amount you are required to withdraw. Financial Consultants Rachel McLain, Addison Schubert and Don Thomas discuss some options.

If this is a year you need to take an RMD, read on for some suggestions on how you can potentially use the money.

Reinvest Your Required Minimum Distribution

Not needing your required distribution amount for today’s expenses is a great problem to have, but it can still be a problem. “Some of my clients wish they didn’t have to take an RMD and would rather keep it invested or are wary of the tax burden,” says Rachel.

Addison agrees, “I have clients who are living off the money and those who don’t need it right now. Of those who don’t need it, they would much rather keep it protected from taxes so they can leave it to their children.”

However, distributions are still required and where you put the money matters. Don says, “Leaving the money in a checking account invites inflation risk, but you do have other options to put that RMD to work for the future.”

Investors often wonder if they can reinvest the money. The answer is yes, with caveats. You can invest an RMD in a taxable investment account—but not back into most retirement accounts.

You might be able to contribute your RMD to a Roth IRA as long as you have earned  income in an amount equal to or greater than the RMD amount you contribute to the Roth IRA. The RMD amount you must take is still considered taxable income in the year you take it. Roth IRAs have no RMDs during your lifetime .

Use Your RMD to Contribute to a 529 Plan

Another solution is to put your RMD into a 529 education savings plan. This way, your RMD can pay tuition or other college expenses for a grandchild or other student, such as an adult who wants to go back to school for an advanced degree. “A 529 allows your gift to grow tax-deferred, and withdrawals for qualifying educational expenses are tax-free,” says Addison. “So even though you are taxed on the withdrawal, the student can still get the tax benefits of a 529.”

To use your RMD to fund a 529, take the distribution as you normally would. Then you can either establish a grandparent-owned account naming the student as beneficiary and invest the money (there may be a required minimum to start the account), or regularly invest it in a parent-controlled 529 account.

You may be able to automate RMDs and 529 contributions so that every time your RMD comes out, a contribution goes into the 529 account. Or you could make deposits into an existing 529 owned by the student or their parents.

If you do open a 529 account, you retain control of the funds. This gives you the freedom to change the beneficiary to an eligible family member if necessary. It also gives you the option to use the funds yourself. However, the earnings portion of non-qualified withdrawals is subject to federal and state income taxes and a 10% federal penalty.

Turn Your Required Distribution Into a Charitable Distribution

“Another good use for an RMD is a gift for someone else—and the gift may also let you enjoy a tax advantage,” says Rachel.

Whether it’s to an arts foundation, a volunteer fire department or an animal rescue organization, you can have your RMD check issued directly to the qualified charity of your choice. This is called a qualified charitable distribution (QCD).

QCDs can be tricky, so you may want to consult a tax professional before using your RMD this way.

Spend Your RMD

A good rule of thumb is to always pay expenses out of your RMD before you cash out other investments. “That’s because you must take the RMD, while other investments could remain untouched,” says Addison.

But if you’ve already got the funds for your normal expenses, like your groceries, taxes and other necessities, you may want to consider using your RMD for your “extra” expenses.

Don says, “Take a memory-making vacation with family. Buy a fire pit. Take salsa lessons. Or make a practical investment, such as a new roof, a reliable car or a more energy-efficient furnace. Enjoying your time or paying for a needed bigger expense—either is a good use of the money you’ve saved.”

Answer RMD Questions by Preplanning

Besides what to do with the money, clients often have related questions: How do I know how much to take, is there a way to be more tax efficient with my RMD and should my investments change when I start taking my RMD? Many of these can be answered by planning.

Your RMD Amount

As mentioned previously, your RMD amount is based on your age and account balance. “Calculating your RMD can seem confusing, but we’re happy to help,” says Rachel. “Those who are part of our Private Client Group advisory services will automatically get their RMD amount as part of our planning services, but any client can call for their amount—or use the RMD calculator if they want to calculate their current-year RMD themselves.”

RMD Tax Strategies

Planning for a future RMD can give you some options, including Roth conversions. “With preplanning—before you need to take the RMD—converting money in a Traditional IRA or 401(k) to a Roth IRA can be a way to reduce RMD amounts, and benefit from tax-free withdrawals in retirement,” says Don. Our RMD planner can help you plan for multiple years.

“Roth IRAs require you to have earned income, and many people who are of RMD age are not still working. That makes the preplanning timing important—before you retire from working or start taking the RMD,” says Addison. “You could also consider the QCDs mentioned previously, which should also be planned at the pre-RMD stage.”

Adjusting Investment Strategies When Taking RMDs

Some investors may wonder if they should change their investment portfolio when they start taking RMDs from their retirement accounts. Don says, “The situation is the boss here. Rules of thumb can be good for conversations, but your personal situation requires more analysis. Investors may want to consider working with a financial advisor regarding their portfolios.”

“It also depends on what the investor wants to do with their RMD,” Rachel says. “If a client is putting the money in their bank account, then we need to look at strategies. We would look at the same factors we would for any client—how much risk you should take and if there are options that may be more tax efficient, such as with an exchange-traded fund portfolio.”

Don’t Skip Your RMD

No matter how you decide to use it—or even if you still haven’t made up your mind—be sure to take your RMD by December 31. If you don’t, the IRS may impose a 25% penalty tax.