4 Financially Smart Ways to Take Money Out of Retirement Accounts

May 1, 2024

Discover how planning for required minimum distributions from retirement accounts can help you fund future needs and support loved ones.

Author
Dan Hunt
Dan Hunt, Senior Investment Strategist

Key Takeaways

  • Generally, when you turn 73, the IRS requires you to take required minimum distributions (RMDs) from tax-qualified retirement accounts.
  • If you don’t need RMDs right away, consider using the funds to contribute to a loved one’s education or donate to charity.
  • You can also reinvest the money toward your future retirement needs by purchasing annuities or converting the amount in excess of your annual RMD to a Roth IRA. 

Whether you’re approaching retirement or already enjoying it, you might be wondering how to make the most of your required minimum distributions (RMDs). Generally, when you turn RMD Age (currently, age 73)1, the federal tax rules require you to take RMDs annually from certain tax-qualified retirement accounts such as traditional individual retirement accounts (IRAs) and 401(k) plans–whether or not you have an immediate need for that money.

 

For many retirees, this is not welcome news. The extra income you get from these distributions both creates a tax drag on your portfolio’s growth and has the potential to be taxed at higher marginal rates. However, any amount not withdrawn by the due date may be subject to a 25% excise tax.2

 

What if you’re fortunate enough to have other sources of income to support your living expenses in retirement and don’t need your RMDs right away? Here are four financially smart ways you can put those funds to work for the future.

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  1. 1
    Help minimize future taxes with a Roth IRA

    A Roth IRA may offer a tax-efficient way to continue saving for future retirement needs and help pass your wealth to loved ones.

     

    While certain high-income earners are not eligible to contribute directly to a Roth IRA, you can convert assets in your traditional IRA to a Roth IRA. Although such a “Roth conversion” will trigger taxes in the year it’s made, once these assets are in the Roth account, they can potentially grow tax-deferred. What’s more, there are no RMDs with these accounts during the lifetime of the owner (but the after-death RMD rules apply) and, if certain conditions are met, withdrawals you make are not subject to federal income tax.

     

    For example, you may want to use the Roth account to invest in a growth-oriented strategy that can help you reach your intermediate or longer-term goals in retirement, such as buying a second home or financially supporting a loved one, without having to worry about a potentially big tax bill coming due in the future.

     

    In addition, a Roth IRA can be a strategic way to transfer wealth. To the extent you don’t need the money during your lifetime, you can leave the assets in your Roth account to continue potentially growing tax-free. Upon your death, your designated beneficiaries will inherit the account and may withdraw funds tax-free if certain conditions are met (though the after-death RMD rules apply and non-spouse heirs typically must withdraw all the funds within 10 years). 

  2. 2
    Help fund a loved one’s education

    Interested in supporting a loved one in their education journey? Consider using your RMDs to invest in a 529 plan, which your designated beneficiary can use for a wide range of educational expenses, including college and K-12 tuition, meal plans, books, laptops and room and board fees. Withdrawals taken for qualified expenses (up to $10,000 in the case of expenses relating to K-12 education) are free from federal taxes and most states’ income taxes.

     

    In addition, contributions to 529 plans can be superfunded, meaning that up to 5 years’ worth of the annual gift tax exclusion amount can be pooled to allow larger contributions within a single year.3 As with any 529 contribution, these are considered “completed gifts,” which means such contributions can qualify for the annual gift tax exclusion. The assets within the 529 plan are generally excluded from your taxable estate for federal estate tax purposes.4

  3. 3
    Support causes that matter to you

    Donating your RMD money to charity may help you support the causes you care about while potentially lowering your overall tax liability.

     

    If you’re at least 70½, you can make a qualified charitable distribution (QCD) from your IRA directly to the eligible charities of your choice. QCDs can be counted toward satisfying your RMDs for the year, up to IRS limits,5 and generally come with no tax costs to you or the charity receiving the donation, potentially helping you give more than you could by donating cash or other assets. 

  4. 4
    Help reduce the risk of outliving your money

    If you’re concerned about outliving your nest egg, consider using your RMD money to purchase an annuity that offers guaranteed income. These products offer competitive after-tax yields and a minimum level of income for the life of you and/or your spouse, potentially reducing the risk that you will outlive your ability to comfortably fund your retirement. However, not all annuities offer the same benefits. A Morgan Stanley Financial Advisor can help find an appropriate annuity for your needs and goals.

     

    This can provide a sense of security and predictability in retirement, which can be particularly valuable if you are planning on a long retirement.

Work with a Financial Advisor

Planning for RMDs can be challenging, but working with your legal or tax advisors, as we as your Morgan Stanley Financial Advisor, can help guide you through each strategy to potentially help you manage the impact of taxes in retirement and plan for your financial future. By using RMDs strategically, you can help bolster your financial security and support the people and causes you love.

Find a Financial Advisor, Branch and Private Wealth Advisor near you. 

Check the background of Our Firm and Investment Professionals on FINRA's Broker/Check.

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