Did you recently receive a required minimum distribution (RMD) from your IRA, beating the Dec. 31 deadline? Excellent. Or perhaps you took this money out earlier in the year. Whatever the case, you're now likely sitting on a decent-sized stash of cash that's waiting to be put to work.
If this is the case, don't sweat it. Here's a list of five savvy uses of any RMD money you'd like to use more constructively. You may be able to utilize more than one of these possibilities, in fact, if there's enough to work with.
1. Park it in a high-yielding money market fund
Assuming you took your required minimum distribution in the form of cash and have yet to do anything more with it, it's probably in your bank checking or savings accounts. And despite their pointlessly low yields, leaving it there for a brief time is fine.
But if your plan is to keep this money relatively available for a while though, there's a better, similar option. As an alternative, invest this money in a higher-yielding money market fund, many of which are paying in the ballpark of 4% to 5%.
These funds are bought and sold just like stock or bond funds, meaning they require explicit trade instructions. That's why your bank may not even be able to offer them to customers who only have checking or savings accounts. If you can move this money to a more conventional brokerage account, you're more likely to have access to this option.
2. Pay down credit card debt
It almost goes without saying that you'll always want to keep any credit card debt to a minimum. After all, you're racking up interest charges on any balances beyond 30 days. If you've got more than a little left to pay on your total debt right now, however, you might want to knock as much of it out as soon as you can.
See, although overall interest rates are still relatively low on a historical basis, credit cards' interest rates aren't following suit. They're at or near record highs. The Federal Reserve reports the average annualized interest rate being charged by credit card issuers right now is a whopping 21.8%, although depending on your card, you could be paying much more. Credit cards issued by retailers are currently charging a little more than 30% per year, on average, with many of them upping these rates without making a bold announcement of these changes.
You'd be hard-pressed to achieve a comparable rate of return on any money not used to pay down this debt... meaning getting rid of this debt is your best investment prospect right now.
3. Use it to cover taxes on a conversion to a Roth IRA
Have you been kicking around the idea of converting your traditional IRA to a Roth IRA so you don't have to worry about taking required minimum distributions ever again (since RMDs don't apply to Roths)? Although such conversions are taxable as ordinary income for the year in which they're completed, the IRS doesn't care where the subsequent tax payment comes from. You could use your RMD money to cover at least some of any such tax bill.
That said, right now may be the absolute worst time for some investors to complete a conversion to a Roth. Why? Because traditional IRAs that are heavily invested in stocks would be undergoing the conversion process at a time when the subsequent tax burden would be quite high, while waiting just a little while longer could lower this burden quite a bit.
See, stocks are now well into record-high territory, and well overvalued as a result. The S&P 500's (^GSPC -1.11%) trailing-12-month price-to-earnings ratio is just above 30, while its price-to-sales ratio is in excess of 3.0. Both are uncomfortably high for what's supposed to be a normal economic environment. It matters simply because a corrective pullback could be on the horizon, which would make it at least a little cheaper to convert your conventional IRA to a Roth.
4. Make a charitable donation
Were you forced to take a required minimum distribution of cash or assets you just don't need, and probably will never need? Although it's too late to take advantage of the IRS's generous qualified charitable distribution rules (which also satisfy RMD requirements), you can still lower your tax bill by giving this money or in-kind distribution of assets away. Doing so of course will reduce your taxable income for the year in which the donation is completed. Just be sure to get a dated receipt or confirmation from whatever charity you're making a gift to.
5. Reinvest it
Finally -- and perhaps most importantly -- just because you're required to remove money or investments out of your conventional IRA doesn't mean this distribution needs to remain held as cash or a cash-like holding. If you needed this money to produce risk-adjusted growth when it was inside a retirement account, you'll arguably still need it to do the same outside that account.
So, reinvest it.
It wouldn't be inherently wrong to reinvest the RMD in the exact same stocks, bonds, or funds it was invested in before the distribution was made (although an in-kind distribution of these assets could have saved you a couple of steps). But, since you've now got some additional liquidity, now's a great time to make adjustments to your overall portfolio's allocation.
Just bear in mind that there are different kinds of investments you'll want to hold in a taxable account, as opposed to a tax-deferred account like an IRA. For example, if you don't actually need dividend income but you still want to own dividend-paying value stocks, holding your growth stocks in a taxable brokerage account will give you more control of your taxable income in any given year. Conversely, dividend payments dished out by dividend-paying stocks held in an IRA don't actually generate taxable income, as these payments are being made. Just optimize your allocation for your particular situation.
