How to Use Your Required Minimum Distributions (RMDs) Strategically

November 17, 2023
Estimated Reading Time: 8 Minutes

As the end of the year draws nearer, many people take this time to review their investment portfolios, determine which charities they'd like to donate to, and start to build their financial roadmaps for the coming year. When it comes to reviewing your accounts, one you may want to pay close attention to is your tax-advantaged retirement account and how much you're withdrawing if you're at a certain age.

In this article, we identify some strategies for fitting an RMD into your financial plan and how to use your RMD to save on taxes and achieve your goals in retirement.

What is a Required Minimum Distribution (RMD)?

A Required Minimum Distribution (RMD) is the minimum amount of money that individuals with tax-advantaged retirement accounts are required to withdraw. RMDs are required to begin no later than April 1st the year following the calendar year in which you turn 72 (or 73 if you reach age 72 after December 31, 2022). RMD rules are in place to ensure that people don't use these tax-advantaged accounts solely as a way to defer taxes indefinitely and that they begin to withdraw the funds and pay taxes on them.

RMD rules typically apply to tax-deferred retirement accounts, including traditional IRAs, 401(k) plans, 403(b) plans, and other similar retirement savings accounts. Roth IRAs, on the other hand, do not require RMDs during the account owner's lifetime because they operate under different tax rules and principles.

How is your specific RMD calculated?

The specific amount of your RMD is calculated based on the fair market value of your IRA at the end of the previous year and a distribution factor provided by the IRS based on your age. The formula typically involves dividing the account balance by the distribution factor.

Are there penalties for not taking an RMD?

Failing to take your RMD or taking an insufficient RMD can result in substantial penalties. Prior to 2023, the IRS could impose a 50 percent excise tax penalty on the amount that should have been withdrawn. With the passing of the SECURE 2.0 Act, this excise tax amount has been decreased to 25 percent, possibly 10 percent if your RMD is corrected timely within 2 years.

It's important to note that the penalty reduction provided by the SECURE 2.0 Act is effective for RMDs in 2023. It does not apply to missed RMDs in prior years.

How is an RMD taxed?

The amount you withdraw as an RMD is subject to income tax in the year you withdraw it. When you take your RMD, it will be added to your taxable income for the year and will be taxed at your personal federal income tax rate.

How to Offset Income from RMDs with Tax Loss Harvesting

Offsetting income from RMDs with tax loss harvesting involves strategically selling investments with capital losses in taxable accounts to offset the taxable income generated by RMDs. To put it simply, this means you're selling investments that aren't doing well in your regular investment accounts and using those losses to lower the taxes you owe on your RMDs. This allows you to take advantage of investments that have lost value to reduce the taxes you have to pay on the money you're required to withdraw from your retirement accounts. It's a way to be more tax-efficient and potentially save money.

What are some ways to use your RMD?

One of the primary purposes of RMDs is to provide a source of income to cover your everyday living expenses in retirement. You can use your RMD to pay for housing, utilities, food, healthcare, and other essential costs. You can also use it to fund discretionary expenses such as travel, entertainment, hobbies, and other activities that enhance your retirement lifestyle.

If you don't immediately need the money from your RMDs to cover expenses, you can reinvest the funds into taxable accounts. This allows your money to keep growing, and you can potentially generate additional income or save for future needs. You could also reinvest your RMDs into tax-efficient accounts or assets to minimize your tax liability and maximize after-tax returns.

You can also use your RMDs to give monetary gifts to charity and family members. However, keep in mind that there is an annual limit that you can gift to an individual tax-free. The 2023 gift tax limit is $17,000. Any amount over this will either be subject to taxes or will count toward your lifetime gift tax exemption.

What are some strategies for fitting an RMD into your financial plan?

There are some ways that you can use your RMD strategically. Generally, we like the idea of deferring taxes as long as possible. Why pay them before you really have to? There will be times when you can start to take some distributions a little early, but that will be completely dependent on your financial plan, with a clear understanding of your income and tax picture.

Additionally, you can use your RMD to your benefit regarding your taxes. For example, if you're in a low tax bracket now and the RMD will put you into a significantly higher bracket, then it may make sense to start taking some distributions a little early. Or, if you're in a high tax bracket and have charitable intentions, you can make a Qualified Charitable Distribution (QCD), which counts toward your RMD. Although you cannot make a QCD directly to your Donor Advised Fund (DAF), you can use the QCD to make a gift directly to that organization, which is a great way to lower your taxable income and enhance your tax position.

Is it better to take an RMD as a lump sum or to take it out in smaller increments throughout the year?

Generally, the markets are upward-sloping and grow over time, so the longer you can keep your capital invested, the better. If you need to use the RMD money to cover living expenses, you can take a distribution on a monthly basis and allow the remainder to stay invested, generating income and return. If the capital is not needed on a monthly basis, you will likely be better served to defer it until near the end of the year so that the capital generates interest and return tax-deferred.

Final Thoughts

There are a number of ways to strategically incorporate your RMDs into your financial plan and help you reach your retirement goals. To learn more about RMDs, contact your advisor. Or, if you're interested in talking with a Chicago Partners advisor who can help you optimize your strategy for using your RMDs, you're always welcome to contact us using the form here.

Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.