Stock market downturns like the one we are experiencing now can leave you in a difficult position as you take required minimum distributions (RMDs) from your retirement accounts, such as 401(k)s and traditional IRAs. You may feel forced to sell your assets at a low price so you can take the RMD rather than wait for those assets to recover when the market climbs once more.
Rather than sell at a low price and take the cash, however, you could reinvest. Reinvesting your RMDs into a taxable account, such as a brokerage account, could help you offset some of the impact of this declining market. By reinvesting, you can wait for your assets to recover and then convert them into cash for your spending needs.
While you would have to pay taxes on the investment gains within your brokerage account, this strategy could still net you more money than if you simply sold your assets at a low price to satisfy your RMD requirement.
How Reinvesting an RMD Works
Once you turn 72 (previously 70 ½), you must begin withdrawing a certain amount from your retirement accounts each year. This rule doesn’t apply to Roth plans but does apply to other plans, such as IRAs and 401(k)s.
The amount you withdraw will be based on your account balance and age. You can use a worksheet from the IRS to get a better idea of what your RMD will be.
Like many people, you have probably seen your portfolio value drop as the markets react to the COVID-19 pandemic. You might think that since your portfolio balance is lower, your RMD—which is taxable income—will be too.
However, your RMD for the current year will be based on your plan balance as of December 31 the previous year. That means the stock market’s drop is not going to be reflected in your RMD this year. You will have to take a higher RMD even though your assets are now at a lower value.
If you don’t need your RMDs to fund this year’s retirement expenses, then you might consider reinvesting the distribution into a standard brokerage account. You could invest in similar assets that you had to sell to take your RMD, and you could then leave those investments in the non-retirement brokerage account for as long as it takes for the assets to recover.
Other Strategies for Handling RMDs
While reinvesting RMDs into a taxable account works well for many investors, you may want to consider other strategies, depending on your personal finances and goals.
For example, you could convert a traditional IRA to a Roth IRA so that you no longer have to take the RMD. What’s more, the Roth IRA’s tax-free growth and distributions could help provide income and tax flexibility in retirement.
However, you will have to pay income taxes on the Roth conversion, and the conversion could potentially affect your tax bracket. If the COVID-19 pandemic means you will receive less income this year, then this consideration might not be as crucial to you.
Another strategy you could try is to have your retirement account custodian make a qualified charitable distribution (QCD) from your account that is equal to your RMD. If you are charitably minded, a QCD can help you support your favorite nonprofits during a challenging time, and you will not pay taxes on the distribution.
Speaking with a financial advisor can help you assess your options and determine which ones are right for you. As a fee-only, fiduciary financial planning firm, we help our clients take these steps and similar ones to help weather and respond to the effects of a stock market downturn.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.