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By Jason Stipp and Christine Benz | 01-29-2015 02:00 PM

Where to Invest Unneeded RMDs

Investors may consider gifting the money or steering it into tax-managed or tax-efficient investments, says Morningstar's Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar. Investors age 70 1/2 must take so-called required minimum distributions from their Traditional IRAs and company retirement plans by Dec. 31 of each year. But they can and should reinvest that money if they don't need it. Here to offer some tips on that is Morningstar's Christine Benz, our director of personal finance. Christine, thanks for joining me.

Christine Benz: Jason, great to be here.

Stipp: RMDs--let's talk first about what these are, why they are necessary, and why the government requires them.

Benz: My mom asks me that every year around the end of the year. The reason is that the IRA or 401(k) or whatever company retirement plan you are using gives you tax-deferred compounding on your money; but at some point, the government wants you to start taking money out so that you can pay taxes on that money. You get a free ride for a certain percentage of time; but then at some point, you do have to start paying taxes.

Stipp: So, because these are required distributions from your retirement accounts, it's really important to pay attention to what those requirements mean and what those distributions mean for your overall spending plan.

Benz: That's right. So, this is especially important if that IRA, 401(k), if those assets that are subject to RMDs are the bulk of your retirement portfolio. You need to stay plugged into that percentage withdrawal that you are taking. One thing to keep in mind is that even though RMDs start out well below 4%, which is oftentimes thrown around as kind of the guideline for safe withdrawal rates, they quickly escalate, because they are based on a life-expectancy factor.

As your life expectancy declines, you need to take more and more. So, by the time you are age 85, for example, your RMDs will amount to about 7% of your IRA or 401(k) portfolio. By the time you are 90, it's about 9% of your portfolio. So, this is not going to be an issue if you have a lot of other assets that aren't subject to RMDs that you are not touching. It won't be a big deal; you won't go outside your planned withdrawal rate. Another thing to bear in mind is that our colleague David Blanchett, who is head of retirement research for Morningstar Investment Management, has said that he actually thinks that these life-expectancy factor tables that are used to calculate RMDs could reasonably help guide retirees on their overall distribution plans. Because as your time horizon shrinks, you can arguably take more and more of your portfolio, because your life expectancy is that much shorter.

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