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“What now?”  Eight Ways to Handle Income from Required Minimum Distributions

The other day, a client said to me, “When I opened my IRA, I remember you saying something about RMDs, but when I heard age 70 ½, I tuned out the rest. Well, 70 snuck up on me and now I need to do something about this extra income. What now?”

Throughout your working years, the IRS cuts you a deal. You may save and invest in a retirement account without paying taxes on the annual earnings until you make withdrawals. But there’s a catch: At age 70 ½, the government decides it’s time to pay up, whether you need the income or not. And you will pay up – in the form of Required Minimum Distributions (RMDs) from your IRAs, 401(k)/ 403(b)/ 457 plans, and other retirement accounts. These distributions will be treated as ordinary income for tax purposes.

Having extra income is a good problem to have, but without a plan of action for re-investing or spending that income, it can seem like a financial conundrum. For many, the forced extra income through RMDs is not welcome news. Frustrated by low interest rates, changing tax laws, market volatility, and greater life expectancy, many affluent Baby Boomers are left shrugging their shoulders about how to handle the added income they feel they don’t yet need.

So, what exactly are the best options for your newly found income? Here are a few smart financial moves and quality of life improvements you can make with your RMDs:

1) Add to your Emergency Fund. If you don’t have an emergency fund, or feel that your savings are inadequate, RMDs can help. It is widely suggested that you maintain 3-6 months of expenses in emergency savings, but we recommend closer to 8-12 months of expenses saved. Consider your personal situation to see what’s appropriate for you.
2) Pay Down Debt. Do you still have a mortgage, car payment, credit card debt, home loans, or equity lines of credit? RMDs can serve as an excellent way to keep your balance sheet in the black.
3) Invest in a ROTH IRA. If your income level qualifies for contributions to a Roth IRA, and you still have earned income, you may be able shelter up to $6,500 for a future date since Roth IRAs are not subject to RMD requirements [1].
4) Fund a 529 College Savings Plan for Grandchildren[2]. While it’s tempting to spoil grandchildren with tangible or monetary gifts, a wiser investment may be contributing up to $15,000 annually to their 529 plan. Newer tax laws allow funds from these accounts to be withdrawn tax-free if used for public/private higher education expenses AND for private elementary & secondary school tuition.
5) Fund Your Estate Plan with Life Insurance. If you haven’t recently reviewed your estate plan, you may want to recalculate your life insurance needs. You may use RMDs to pay premiums on new or additional coverage, which may help your beneficiary’s income replacement needs, and protect your assets from estate tax depletion.
6) Investigate Long Term Care Insurance Options[3]. While purchasing Long Term Care insurance as a retiree may be pricey, the actual cost of long-term care may be even more expensive (median cost for nursing home care in 2017 was over $97,000/year) [4] . Investing your RMDs into coverage for your future needs may be a consideration.
7) Donate to Charity via a QCD. A Qualified Charitable Distribution is a direct transfer of funds from your retirement account to a charity of your choice. The donated amount is excluded from your taxable income. [5]
8) Take the Trip! If you have always wanted to go on a safari, tour Europe, or bask in the sunshine of the Caribbean, there is no better time than now. If you’re healthy and can escape your other obligations, a vacation to a new place can be a refreshing way to refocus and rejuvenate.

As always, consult with your financial and tax advisors to determine the best strategy for managing your RMD income stream.

[1] https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2018
[2] https://www.irs.gov/newsroom/529-plans-questions-and-answers
[3] https://www.aarp.org/health/health-insurance/info-06-2012/understanding-long-term-care-insurance.html
[4] https://www.forbes.com/sites/nextavenue/2017/09/26/the-staggering-prices-of-long-term-care-2017/#35d9e89c2ee2
[5] https://www.fidelity.com/building-savings/learn-about-iras/required-minimum-distributions/qcds