How to Make the Most of Your RMDs

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. There's a lot of important end-of-year deadlines, but for retirees RMDs are one of the most important. I'm here with Christine Benz, she is our director of personal finance, for some quick tips.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: Let's start just with the basics of what required minimum distributions are, who is subject to them, what kind of accounts do you need to take RMDs from?

Benz: Generally speaking, these are traditional tax-deferred accounts. This would be your traditional IRAs, traditional 401(k)s, other company retirement account assets. Roth assets, Roth IRA assets are not subject to required minimum distributions; Roth 401(k) assets are. It can be hard to it all straight, but it's very important to make sure that you take your RMDs on time. Because if you miss an RMD, you are subject to an IRS penalty that's equal to 50% of the amount that you should have taken but didn't. It's not something you want to mess around with.

There's a little bit of a workaround. If it turns out that you missed an RMD and you were just completely not intending to miss that RMD, you can generally get out of that penalty. But it's best to avoid it altogether.

Glaser: Your first tip is about which accounts to take the RMD from. You mentioned a bunch of different account types. But you don't have to take an RMD from every single eligible account, every year?

Benz: Right. Generally speaking, as long as you calculate the right RMD amount for all of your accounts of a given type, you are in good shape. Say you have multiple traditional IRA accounts, and that's often the case with people if they've had multiple employers, for example. You simply have to calculate the right amount to take per account, but then you can roll them all up and take the RMD from a single holding or a single account. You don't need to take a portion of each and every RMD-subject account.

Glaser: The second tip is to use this as an opportunity to improve your portfolio and to really think about what you are doing.

Benz: Absolutely. I'm a big believer in--even though retirees love to hate their RMDs because they do cost them taxes--I do like the idea of taking a step back and looking at your portfolio and potentially pruning from holdings that were problematic for one reason or another. Maybe it's simply that you have a holding that's too large a position in your portfolio or something that you didn't really like, you were revisiting your thesis for the position, that's a great candidate for your RMDs.

Also, I love the idea of people using our X-Ray functionality to see where they have potentially portfolio imbalances. Maybe you determine that even after the market volatility that we've had recently, you still have an equity overweighting. Use the RMD to help address that situation, and incidentally, you don't have to stop with RMDs. If you determine that you've got a big issue with your portfolio's allocations, you can also address that by doing some repositioning. RMDs are a great way to at least get that process started.

Glaser: Let's talk about the QCD or the qualified charitable distribution. When is this a good idea?

Benz: It's often a good idea for people who make any charitable contributions at all who are also subject to required minimum distributions. The real beauty of the QCD is coming to light in 2018 and will be on display for the next seven or so years, where if you have RMDs that you have to take, and you want to direct a portion of those RMDs, up to $100,000, to charity, you can do so.

A key piece of advice I would say is, let your provider work with the charity or charities of your choice on enacting this distribution. They will ensure that the paperwork gets done correctly. But the beauty of using the QCD versus pulling the RMD out and then potentially writing a check to charity is that many fewer taxpayers will be itemizing their deductions starting in 2018. They will get a bigger bang from the standard deduction. The QCD helps ensure that you do get credit for that contribution to charity because your adjusted gross income is not inflated by the amount of the RMD that you send to charity. It's a great strategy. If you are unsure about how it works, check with your tax preparer.

Glaser: And finally, you think investors should be reminded that they don't need to spend the RMD; it might be prudent to reinvest it.

Benz: Absolutely. I often get this question. Someone will say my RMD is actually taking me to a higher withdrawal rate than I would care to spend from my portfolio at this point in time. You don't have to spend it. The money has to come out of the account but there are no rules around what you do with the money. Oftentimes, I talk to especially affluent retirees who are putting the money back into their portfolios in some fashion, one thing to know is that if you or your spouse has at least enough earned income to cover the amount of your contributions, you can actually steer that money into a Roth IRA. That's a good strategy for people who don't need their RMDs. For many other folks, they will not have earned income at this life stage, a better strategy is to steer that money into a taxable account. Just make sure that you are investing that account very tax-efficiently.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.