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4 Ways to Manage Your Required Minimum Distributions When You Don’t Need the Money

After years spent saving, many retirees find it hard to shift gears and start spending—leaving them with more money than they know what to do with when they’re required to start making withdrawals.

More than half of customers with Fidelity Investments who have traditional individual retirement accounts take out only their required minimum distribution amounts starting at age 70½, choosing instead to keep their money invested for as long as possible, the company says.

The reasons vary, says Keith Bernhard, vice president of retirement income at Fidelity. Many fear unexpected health-care expenditures, while others just want to keep growing their assets in a tax-deferred investment vehicle. And still others are protecting their nest eggs while adjusting to life without a paycheck.

“Folks are generally a little bit uncomfortable with the idea of seeing their savings decrease, decrease, decrease, even if they’re probably not going to spend it all,” Bernhardt says. “There can be a tendency to be conservative, not knowing what’s coming ahead.”

Still, those RMDs, as established by the Internal Revenue Service, have to go somewhere, so what should retirees do with that money when they don’t need it for living expenses? Here are some tips:

Make a qualified charitable donation. QCDs go straight from IRAs to charities, so account holders never receive the money and it doesn’t count as taxable income. That’s important for retirees, Bernhardt says, because if they increase their taxable income too much, they could face higher taxes on their Social Security benefits and surcharges to their Medicare premiums.

In addition, he says, with the standard deduction roughly double what it used to be, most taxpayers no longer itemize their deductions and thus don’t get a tax benefit for donations made from ordinary savings accounts.

Reinvest the RMD in a money-market account or another investment vehicle. Retirees who want ready access to their RMDs to pay for unexpected expenses should consider a money-market account or other interest-bearing vehicle, Bernhardt says.

“Even if you’re going to park your RMD in cash, make sure that cash is working for you and you’re getting an interest rate that you deserve,” he says. “Just because it came out of the IRA doesn’t mean it can’t still keep working for you.”

Another option is to put the money in a brokerage account and invest it in the same type of vehicle as in the IRA, such as an index-tracking fund.

Reduce RMD amounts by converting a portion of your traditional IRA to a Roth IRA. In the years immediately after retirement, many seniors get by on Social Security and their savings, so their taxable income is relatively low. That makes it a good time to consider converting a portion of a traditional IRA to a Roth IRA, which will lower RMDs in the future, Bernhardt says.

Seniors will pay taxes on withdrawals from their traditional IRAs, but Roth IRAs offer several benefits that might justify making the conversion, he says. Roth IRAs have no RMDs, seniors don’t pay taxes on withdrawals, and their money is still invested in a tax-advantaged way.

However, it’s important to note that seniors will pay penalties if they withdraw money transferred to a Roth IRA from a traditional IRA within five years, Bernhardt says. “You shouldn’t do this if you feel that you might need quick access to the money in the Roth IRA,” he says.

Retirees can convert money from a traditional IRA to a Roth IRA over several years to avoid getting bumped into a higher tax bracket in any one year, Bernhardt says.

Decrease RMDs by purchasing a qualified longevity annuity contract. Seniors can use as much as 25% of a 401(k) or IRA, up to $130,000, to purchase a QLAC, Bernhardt says. The assets used to purchase the deferred annuity aren’t taxed, though the monthly payments from the annuity will be taxed. The retiree can choose to start receiving payments at any age up to 85, and the longer the senior delays collecting, the higher those monthly payments will be.

Since purchasing a QLAC lowers the total value of the 401(k) or IRA account, future RMDs will be reduced.

The guaranteed income does come with drawbacks, however. Retirees miss out on any potential investment gains that would have come from the principal amount used to buy the QLAC, and seniors typically have to live until their late 80s or longer just to recoup the principal. In addition, they have less liquidity in their retirement accounts and less assets to leave to their children.

Is that worth the peace of mind of having additional guaranteed income late in life? For some, the answer may be yes.

“This helps to remove some of that longevity risk that you might otherwise have,” Bernhardt says.

Questions? Comments? Write to us at [email protected]

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