What You Need To Know About RMDs
Investing in tax-deferred retirement plans is one of the unique situations where you receive the benefits in the early years, but the benefits have an expiration date.
To give you an incentive to save for retirement, the government allows you to put money into an IRA without paying taxes on the funds you contribute; however, they eventually want to collect tax revenue on those funds, so they require you to withdraw a minimum amount and pay taxes on it. The amount you are required to withdraw is called a Required Minimum Distribution (RMD).
RMDs exist to prevent tax-deferred accounts from being passed on from one generation to the next without taxes being paid on the funds. The government requires you to start taking RMDs when you reach age 70 ½. The minimum distribution amount varies and is calculated according to an IRS formula based on your age and the balance in your account at the end of the previous year.
While the rules take up dozens of pages of Treasury regulations, the main point I want to make is that while you are required to withdraw this money, you are not required to spend it.
What to do with your RMD
Unless you are wealthy, the one thing you don’t want to do with your RMD is spend it on unnecessary luxuries. Above all else, your RMD should not be regarded as a windfall or “found” money.
If you think you might need this money in the future, you can reinvest the after-tax amount in a taxable account, or you could use it to pay down debt that will reduce future interest expenses, such as on a home mortgage. If you do not anticipate needing your RMD for expenses, but you’d like to use it to gain tax advantages, then consider having your RMD directed toward charitable contributions.
If you have an inherited IRA and are behind in saving for your own retirement, for a college fund, or other major expenses, then the most prudent use of your RMD would be to reinvest it. Someone worked very hard to earn and invest this money wisely. The best way to honor their gift is to put the money to work for you.