Saving for retirement in a traditional IRA or 401(k) plan has its benefits. Not only are investment gains in these accounts tax-deferred, but your contributions are tax-free, making it easier to fund your savings in the first place.
But if there's one drawback associated with saving in a traditional retirement plan, it's having to deal with required minimum distributions, or RMDs.
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The purpose of RMDs is to help ensure that retirement savings vehicles like IRAs and 401(k)s don't become tools that help wealthy Americans pass down an inheritance in a tax-advantaged manner. Rather, the IRS wants IRAs and 401(k)s used as a way for people to cover their expenses during retirement. So to that end, there's the obligation to withdraw at least a portion of your balance each year.
For many seniors, RMDs aren't actually a problem, because it's money that's needed anyway to cover expenses. It's when you don't need your RMD that the obligation to take a withdrawal becomes a hassle, since it creates a tax liability. So if you're in a position where you don't actually need the money from your RMDs, here are some options to look at.
1. Open a CD
Just because you're required to remove money from your IRA or 401(k) plan doesn't mean the IRS is going to force you to spend it. If you want to put that money to work in a risk-free fashion, you can use it to open a CD.
Now to be fair, that may not be your best move in a lower interest rate environment. But right now, CDs are paying pretty generously, making them an appropriate choice for retirees who are looking to generate income without taking on the risk of a stock portfolio.
2. Invest in a taxable brokerage account
If you make a point to manage your risk allocation wisely in retirement, you can safely load up on stocks and other assets whose value can fluctuate from week to week. So you may want to take the money you're removing in RMD form and invest it in a taxable brokerage account that doesn't come with restrictions like IRAs and 401(k)s do.
From there, the choice is yours. If you're interested in ongoing income, you can invest your RMDs in dividend stocks. If your goal is to generate strong returns without taking on too much risk, consider an S&P 500 ETF for broad exposure to the market.
3. Give the money to charity
An RMD can increase your tax burden in two ways. First, your withdrawal itself is taxable, but also, that extra income could bump you into a higher tax bracket overall.
If you want to get around that, giving away your RMDs to a registered charity is a great option. And you may want to look to a qualified charitable distribution (QCD), which has your RMD going directly to a charitable organization instead of you cashing a check from your retirement plan and then writing out another one.
RMDs don't have to be a hassle for you in retirement. If you're forced to take them, know that you can put those withdrawals to work or give them away to avoid the tax hit involved.
