Reinvesting Your RMD as a Retiree? Here’s What You Need to Know.

Is a required minimum distribution (RMD) on your near-term radar? If you’ll be 73 years old or older at any point this year and you’ve got a non-Roth IRA of any size, then the answer to the question is “yes” — whether you need it (or even want it), you’ll soon be taking a distribution from this account. The IRS requires it, in fact. That’s why it’s called a required minimum distribution.

That doesn’t mean you can’t do something productive with this withdrawal, though. Indeed, anyone who doesn’t need this money to cover ordinary living expenses may want to simply reinvest it. Before putting any of this money back to work, however, there are a handful of important details to consider.

But first things first.

What’s a required minimum distribution?

Just as the name suggests, a required minimum distribution is a mandated — and taxable — withdrawal from an individual retirement account, or IRA. These accounts are typically funded with tax-deductible contributions, and allowed to grow without being taxed as long as the investments made with this money remain in the account. The IRS eventually wants to collect, of course, so once you turn 73, the agency comes knocking.

But what’s the minimum? Well, it depends. It’s always a percentage of the prior year’s ending value of the IRA in question, for the record, but that percentage grows the older you get. For instance, the RMD for a 73-year-old is just a tad over 3.77% of the previous year-end value, while for 85-year-olds, the RMD is 6.25% of the account’s value as of the last business day of the prior year. At 100 years of age, it’s about 15.62% of the prior year’s final balance.

The IRS provides forms to help you determine your exact RMD, although your brokerage firm or IRA’s custodian will supply you with the relevant year-end value needed to make the calculation.

There are some other noteworthy rules to know. One of them is that the rules don’t apply to Roth IRAs. After all, these accounts are funded with after-tax (nondeductible) dollars, and as such, withdrawals from them are tax-free. Since the IRS isn’t due anything from these distributions, the agency doesn’t care when, if, or how much — or how little — you remove from a Roth account.

Also, if you happen to have more than one eligible individual retirement account, you don’t necessarily need to take an RMD for every single one. You can mix and match, so to speak; the IRS is only concerned that you remove the total proper dollar amount in any given tax year. Exceptions to this rule are 401(k) accounts and similar 403(b) accounts. You must take the correctly calculated RMD for each and every 401(k) you own.

You can combine required minimum distributions for 403(b) accounts, as long as you withdraw the proper amount in any given year. But you can only remove this amount from some combination of your 403(b) accounts.

Finally, there’s timing. Required minimum distributions are to be completed by the end of the calendar year. The one exception is your first one for the year you turn 73. That one doesn’t need to be done until April 1 of the calendar year after your 73rd birthday.

Just be careful if that’s your plan. Waiting to take your first RMD until the year after you turn 73 will mean making two taxable withdrawals in one tax year, which could bump you into a higher tax bracket.

What you need to know about reinvesting RMDs

Those are the basic logistics of required minimum distributions. But what about strategically making the most of RMDs if you’re simply going to reinvest these withdrawals? Here are four key things to know.

1. You may not need to sell and then buy anything

Most required distributions are made in the form of cash, and often funded by the proceeds from the sale of an investment (or multiple investments). This isn’t your only option though. You could also take what’s called an in-kind distribution of assets like stocks, bonds, or funds. You’ll simply need to give your custodian or brokerage firm these instructions; the total value of the RMD will be determined as of its pricing the day the transfer is completed.

There’s no additional tax benefit in using this approach, to be clear — the tax due is determined by the dollar value of whatever’s being withdrawn the day of the withdrawal. It’s just one of convenience, allowing you to stick with your current allocation without risking a disadvantageous sell and repurchase.

2. It’s an opportunity to optimize the taxability of your accounts

That being said, if you’re already doing a bit of management with your IRA and brokerage accounts, you may as well optimize for this shift of assets from a tax-deferring account to a taxable one.

What this means will differ from one investor to the next. If you want or need investment income in retirement, your RMD would be best used to purchase dividend stocks or interest-bearing bonds. If you don’t need the money anytime soon and would like to continue minimizing your annual tax bill, growth stocks give you more control of when you create a tax liability with a capital gain.

3. The required minimum isn’t the allowed maximum

For most investors, one of the chief goals is minimizing any given year’s tax bill. Taking the bare minimum required withdrawal from a non-Roth IRA will of course help accomplish this goal. You don’t necessarily have to take the minimum possible amount, however. There may be cases when it makes sense to make more than the required minimum withdrawal from your IRA, even if doing so increases that year’s tax liability.

For instance, you might need to free up enough cash to meet a new and immediate investment-income need. Another possibility could be a married spouse intentionally pushing their combined taxable income right up to the very brink of a higher tax bracket, knowing that the other spouse will soon begin their sizable RMDs. This will mean smaller required distributions from the first spouse’s retirement account(s) in the future, perhaps preventing that dreaded push into a higher tax bracket.

Just bear in mind such cases are relatively rare, and won’t likely apply to your situation.

4. You don’t have to make the decision right now

Finally, if you’re a retiree looking to reinvest your required minimum distribution, remember that you don’t necessarily have to do something productive with this money right away. You can think about it for a while if, for example, stocks have soared to frothy levels that leave them vulnerable to a sizable sell-off. You’re likely to make a more level-headed decision when you’re not feeling rushed.

Just don’t get too complacent if this is your plan, particularly if you’re taking your RMD in the form of cash. Most brokerage accounts’ basic money market funds aren’t paying much more than low-yield checking accounts or banks’ savings accounts. If you’re willing to place a simple trade, however, you can park this money in a money market fund that’s yielding on the order of 4% to 5%. That’s not huge, but it certainly tops inflation.