Required minimum distributions (RMDs) are mandatory withdrawals that you must take from your tax-advantaged retirement account, like a 401(k) or traditional IRA, beginning at age 73 (or 75 if you were born in 1960 or later). The amount you must withdraw is based on your account balance and life expectancy. In short, RMDs are the government’s way of ensuring you pay taxes on contributions made tax-free years earlier, as well as any earnings.
Reinvesting your RMD as a retiree can be a strategic financial decision. However, before making any big decisions, make sure you’ve considered the move from every angle. Here’s what you need to know about reinvesting during those critical retirement years.
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There are tax implications
When you take your RMD, it’s considered taxable income for the year in which it’s withdrawn. Even if you reinvest the RMD, you’ll owe taxes on the amount you withdrew.
Investment options
If you’re laser-focused on finding the best places to reinvest your RMDs, take a look at:
- Roth IRAs (if you meet the income requirements).
- Certificates of Deposit (CDs).
- Money Market Account (MMA).
- Taxable brokerage accounts.
- Annuities.
- Real estate or a real estate investment trust (REIT).
A chance to diversify
One often-overlooked benefit of reinvesting your RMDs is the opportunity it provides to diversify your portfolio, potentially enhancing your returns. The same advice applies to reinvesting RMDs as applied to your initial investments. Identify your risk tolerance and ensure you have a specific strategy in place.
Strategizing
Part of your post-retirement budget will come down to balancing your immediate needs with long-term goals. If you rely on RMDs to cover living expenses, make sure you know exactly how much you need to pay those expenses so you don’t find yourself short. Remember to factor in your emergency fund and consider how much you might need if you encounter a financial setback.
Points for consideration
The following can impact whether you want to reinvest RMDs and, if so, whether you prefer to do it alone.
- Tax bracket: Be aware of how an RMD will impact your tax liability. If your goal is to keep your overall tax liability low, taking a distribution that’s too large can push you into a higher tax bracket. Deciding how much to take can be a delicate balance.
- Timeline: The type of investment you decide to make with your RMD should depend, in part, on whether you plan to use the funds in the near future or want to save them and let them grow for years. If you opt for long-term growth, consider equities and other growth-oriented investments.
- Withdrawal timing: While RMDs must be taken by Dec. 31 each year, you have the option of making withdrawals earlier in the year if it makes budgeting easier.
Given the complexity of tax implications and investment strategies, you may consider working with a financial or retirement advisor who can provide personalized guidance and walk you through your options. After all, reinvesting your RMD can be a smart move if done strategically. Success depends primarily on three factors:
- Understanding the tax implications.
- Your personal financial goals.
- Ensuring your investments align with your overall retirement strategy.
Even if you don’t currently need the money you’re required to withdraw, it’s good to know you can still put it to use.
