Read any magazine or newspaper or watch any financial television show and you will learn about the importance of saving for retirement, how much you should save, and what type of account to save your money in. But you don’t hear much about what to do when you are required to make a distribution from your retirement account. What are your options with the money?
In most cases, you will need the money and use it to pay for your daily living expenses. But what if you are in a situation where you really don’t need the money to get by financially? Or what if you only need a portion of it? Sadly the IRS doesn’t care and still requires that you take a minimum amount of money each year.
I am going to walk you through some options for what to do with your required minimum distribution.
What is a Required Minimum Distribution?
Before we get into the options you have with this money, let’s first make sure that we all are on the same page when it comes to what a required minimum distribution is.
A required minimum distribution is an amount of money the IRS requires you to withdraw from your retirement plan every year once you turn 70 ½ years old. Read How to Calculate RMDs to help you to determine how much you need to withdraw each year and when you have to take your first and subsequent distributions based on your birthday. Be sure to understand the rules about delaying your first distribution since it can push you into a higher tax bracket.
You need to understand that most retirement plans do require a minimum distribution. These include traditional IRAs, SEP and SIMPLE IRAs, 401k, 403b and profit sharing plans. Excluded from the list is the Roth IRA. You do not need to make a required distribution from a Roth IRA. The only time one is required is if the owner passes away. The person who inherits the Roth IRA will be required to make minimum distributions each year.
What happens if you fail to take the required distribution? The IRS hits you with a penalty – a 50% penalty on the amount you didn’t take. So, if you were required to take $25,000 and only took $5,000, the IRS is going to hit you with a $10,000 penalty. This is why it is important to take your required distribution each year.
What to Do With Your Distribution
Now we get to the good part – what to do with your distribution assuming you don’t need all of it. Here are some great options for you:
Invest the money: You can’t put the money back into a retirement account, but you can certainly invest the money into a taxable account. This will allow for the money to keep growing at a decent rate of return each year until you do need the money.
Donate the money: Another option is to make a donation to a charity of your choice. You will not only be helping those in need, but you will help yourself as well. By making a charitable contribution, you will get to write off a portion of the donation on your taxes, saving you money. Some brokers even allow you to put the money into a charitable trust so that you can donate it over a few years if you would like.
Gift the money: Maybe you have a grandchild that is getting ready for college or just graduated. You can give them a gift by giving them the money to pay for college or buy their first house. You could even set the money up in a trust so that they can get the money at a later date.
Pay off your mortgage: If you still have a mortgage, you can consider making a large principal payment on the loan to help you pay it off faster.
Be an angel investor: Ever want to help an entrepreneur succeed? This could be your chance. If you find someone with a great idea, you can invest in the business or idea.
There are even some small angel investing networks around the country that team up to invest in new startups all of the time. A quick online search will help you find any in your area. Make sure you talk with a lawyer first to be sure you aren’t just throwing money away.
Start your own business: Of course, you could skip the part about being someone else’s angel investor and be your own by investing in an idea you have. Just be sure to set some ground rules so that you are smart with how much money you put into the business or idea and when to call it quits.
In the end, having to take a required minimum distribution isn’t the end the world. As long as you get creative with how to use the money (assuming you don’t need it to live off of), you can help others or even help yourself.
Take the time to understand what is most important to you and see how a small windfall can help a cause or another person to be better off down the road.