Nov 26, 2024
Required minimum distributions (RMDs) are a fact of life for most Americans once they reach the age of 73 — and while many retirees may welcome the additional income from the mandatory annual withdrawals, what happens if you don’t actually need the funds just yet?
Essentially, an RMD is an annual withdrawal from a pre-tax retirement account, mandatory under Internal Revenue Service (IRS) rules. These include 401(k)s, 403(b)s, 457s, the government TSPs, and traditional IRA accounts.
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As always, RMDs are due at the end of the year — December 31, to be exact. Should you fail to take out the minimum distributions by that date, the IRS will penalize you with a special excise tax — but more on that in a minute.
Let’s say you’re 73 years old and enjoying a comfortable retirement — but you don’t technically need the funds you’re required to withdraw from your pre-tax accounts. So, what can you do? Fortunately, there are a few savvy ways to make the funds work for you.
Here's what you need to know about required withdrawals from your investment accounts — along with tips on how to handle the cash if you don't need it in the immediate future.
What are RMDs — and the possible IRS penalties?
When you put money into a 401(k) or a traditional IRA, you get to deduct your contributions from your income, so you're investing with untaxed money.
Once it's invested, your money will grow and you won't have to pay taxes on the gains either.
At some point, though, the government will want its cut. As per the IRS rule, you must annually withdraw a minimum amount from every tax-deferred retirement account you own.
To ensure you actually make withdrawals — and don't just let your money sit in your account forever — the government requires you to start taking some money out when you reach the age of 73 (if you hit that age after December 31, 2022 — otherwise, it's even earlier).
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The “magic number,” as it were, that you must withdraw is based on the total value of the account at the end of the previous year and a figure referred to as a “life expectancy factor.”
So, RMDs for the current year are calculated based on the account balance as of December 31, 2023. If you don't take an RMD, or take a distribution that is below the required amount, the penalties can be steep.
The SECURE Act 2.0 Act excise tax rate is a hefty 25%; possibly 10% if you correct the issue within two years.
For example, let’s say your RMD should be $20,000 and you withdraw only $10,000 — you would be given a $2,500 penalty. You would still be liable for the tax on the full $20,000. For that reason alone, it's important to know your RMD each year and withdraw the required amount.
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If you don’t take your entire minimum distribution for 2024, the excise tax will be applied on your April 2025 tax bill.
The IRS has provided worksheets to calculate the required amount and there are also tables to help.
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Some alternative ways to use your RMDs
For many seniors, using RMDs for everyday living expenses, paying down lingering debt, or splurging on a vacation can result in a happier, carefree retirement.
However, for those who don't immediately need, or want, the funds, it can be frustrating to sort out how best to use the funds in a way that aligns with your financial goals.
One option you have is to reinvest the money. You can reinvest the funds you withdraw into a certificate of deposit (CDs), treasury bonds, or into the stock market, depending on your risk tolerance.
Alternatively, if you want to avoid a sizable tax bill and you don't think you'll need the money now or in the immediate future, you could opt for a qualified charitable deduction (QCD). This would involve transferring the IRA assets directly to a charity of your choice.
This is treated as an above-the-line deduction, so you can claim it even if you take the standard deduction and you won't increase your taxable income — which could have consequences for both your tax bracket and the taxation of Social Security benefits.
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Christy Bieber has 15 years of experience as a personal finance and legal writer. She has written for many publications including Forbes, Kilplinger, CNN, WSJ, Credit Karma, Insurify and more.
