You don’t have to write off those withdrawals as lost or wasted money.
There’s a reason so many people are motivated to save for retirement in a traditional IRA or 401(k). These plans give you a tax break on contributions, thereby lowering your IRS burden in any year you make them.
Plus, unlike a regular brokerage account, you don’t pay taxes on investment gains year after year in an IRA or 401(k) plan. Rather, you’re taxed at the time of your withdrawals, which delays the tax burden until retirement.
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If there’s one drawback of housing your retirement savings in a traditional IRA or 401(k), it’s being subject to required minimum distributions, or RMDs, later on. In the past, RMDs kicked in at age 72, but recent changes have pushed that age back to 73 for anyone born before 1960. And if you were born in 1960 or later, you’re liable for your first RMD at 75.
You might assume that RMDs have the potential to wreck your retirement finances because they not only force you to spend the money in your IRA or 401(k), but also create an immediate tax burden. But both of these points are flawed ways of thinking.
You have more options for your RMDs than you think
It’s a big misconception that the money you remove from your IRA or 401(k) in RMD form is money you have to spend. The IRS doesn’t care what you do with your money once it’s out of your retirement account. It just has to be removed on time to avoid a penalty.
But there’s absolutely no requirement to spend your RMD if you don’t need the money. You could put it into a savings account, use it to open a CD, or invest it in stocks, bonds, and other assets. You just generally can’t put it back into a tax-advantaged account.
Furthermore, you may have heard that you can’t use a traditional IRA or 401(k) to pass wealth onto your heirs because of RMDs. But again, RMDs technically don’t stop you from doing that. You could take the money from those mandatory withdrawals and use it to set up an account for your beneficiaries.
You may be worried about the tax impact of taking RMDs. But if you donate your RMDs to a registered charity, you won’t be taxed on your withdrawals. So if there are causes that are important to you and you don’t need the money, that’s a route worth considering.
RMDs aren’t the end of the world
A big reason some people opt to save for retirement in a Roth account is to avoid RMDs. And you could always do that if you truly expect them to be a problem. But if a traditional IRA or 401(k) makes more sense for you, based on factors like your current tax bracket, then RMDs aren’t necessarily the terrible thing they’re often made out to be.
Sure, it would be nice if you could have full autonomy to decide when a portion of your money needs to leave your retirement account. But if you manage your RMDs wisely, you may find that you’re able to make good use of them without increasing your tax burden exponentially.
