What To Do About Required Minimum Distributions (RMDs)

When you turn 70½ the IRS requires that you withdraw a minimum amount from your retirement account(s) each year. If you don’t take your required minimum distribution, or RMD, you face a steep penalty of 50% of the amount that should have been withdrawn. The RMD rules do not apply to Roth IRAs, at least while the account owner is alive, but they do apply to Roth 401(k) accounts

RMDs can be a challenging part of retirement investing, and we’ve had many questions about RMDs from investors who set up a retirement consultation with us. Here are some of our tips on how to best handle your RMD:
 

Should I take my RMD in one lump sum or in installments? Early in the year or later?

If you need the cash for your spending needs, you can set up a monthly or quarterly withdrawal through your broker or custodian. To calculate your monthly payout, divide the total required for the year by 12 and use that as your monthly distribution. You’ll need to make sure the cash is available each month or quarter to accommodate the withdrawal.

If you don’t need the cash now, consider taking your RMD in one lump sum later in the year. This gives you time for extra tax-deferred growth in your account, since the market is often (though not always!) higher at the end of a year than at the start. Over the past 90 years, the S&P 500 ended higher 73% of the time, 66 years of gains and 24 years of losses.
 

How should I raise the cash for the withdrawal?

One way to raise cash for your RMD is to use a monthly Upgrade: just set aside part of the proceeds from a sale for your RMD, and invest the rest in a highly ranked fund. The downside to this method is that your portfolio might be holding less of a highly ranked fund. But it is a little easier than selling off shares of several funds on a pro-rata basis and you’ll likely avoid unnecessary transaction costs.
 

What should I do with my RMD?

Just because the IRS requires you to take the money out of your IRA each year does not mean you are required to spend it. When we manage RMDs for our clients, we often will move the money from a client’s IRA and into a taxable investment account, often one that is managed in a very similar, yet tax-efficient way.
 

How much must I take, and how will it affect the sustainability of my portfolio?

To calculate your distribution, divide your December 31 account balance by your life expectancy, as laid out in the IRS’s RMD worksheet. For the first year, this denominator is 27.4, which works out to 3.65% of your account value. This is well within the famous 4% rule of thumb for a sustainable initial withdrawal rate.

The 4% rule assumes you can increase withdrawals each year by the amount of inflation to support your spending power. Assuming a 3% inflation rate (which is higher than the CPI has been for a number of years) your withdrawal at age 80 would be 5.38%. Using the IRS’s calculator, your RMD at age 80 would be 5.35%— so it’s still pretty close to the “safe” withdrawal rate. After age 80, however, your RMD amount will start to become a little higher than the “safe” rate of withdrawal. By age 90, for example, your RMD will be 8.77% vs. 7.22% “safe” withdrawal. At that point you may want to consider spending less than the RMD and directing part of your withdrawals to a taxable investment account.
 

Can I donate my RMD to charity?

If you normally make donations to charitable organizations, a qualified charitable distribution (QCD) may satisfy the RMD for the year in which it is made. Generally, IRA distributions are treated as taxable income but a QCD may be excluded from income if you instruct your IRA custodian to make your distribution directly to the qualifying organization. Make sure to obtain acknowledgement of the contribution from the organization.

Janet M. Brown, president of FundX Investment Group and managing editor of NoLoad FundX, joined FundX in 1978. Janet has been researching funds and developing successful fund investment strategies for many years. Prior to joining FundX, she worked in Brussels with a financial services company where she specialized in mutual funds. Janet is frequently interviewed by the media on investment and mutual fund issues.