Skip to Content
US Videos

Making Smart Decisions With RMDs

Vanguard's Maria Bruno explains how to be strategic with your required minimum distributions.

Christine Benz: Hi, I'm Christine Benz for As the year winds down, required minimum distributions are top of mind for many retirees. I recently sat down with Vanguard senior investment analyst Maria Bruno to discuss how investors can make smart decisions about RMDs.

Maria, thank you so much for being here.

Maria Bruno: Thanks, Christine. Thanks for having me.

We're just starting what I think of as required minimum distribution season. Let's talk about these required minimum distributions. Which account types are subject to them?

Maria Bruno: It is really focused on tax-deferred retirement accounts. Typically, let's start off with traditional deferred accounts. These are 401(k)s or employer-sponsored plans or IRAs where as an individual you make contributions. Those contributions are tax deductible. The accounts grow tax-deferred and then later in retirement, when you take withdrawals, whether they are required or not, the entire pre-tax balance would be subject to income taxes.

There's also Roth accounts. Roth IRAs are not subject to required distributions in retirement. In fact, that's one of the benefits to those types of accounts. Roth 401(k)s are subject to required distributions, although they would not be taxed.

Benz: If you add a Roth 401(k), you could presumably roll it over into a Roth IRA and then it would not be subject to RMDs, right?

Bruno: Correct, and that's one of the benefits and one of the reasons that many individuals do that. The key there is to do that before the distribution requirements kick in. Because if you do that after, then you still need to take that distribution. It's one of the reasons that individuals tend to--and there's many reasons--but that's one of the benefits to rolling into a Roth IRA in that you don't have to take those distributions.

Benz: The RMDs must commence once you pass age 70 1/2. If you forget to take them, don't take them, you are subject to that 50% penalty. You absolutely want to mind that deadline which is Dec. 31?

Bruno: Correct. Steep penalty if you don't take it. You do, in the year you turn 70 1/2, you have that option of deferring until April 1 of the following year. That's a unique feature. It's a one-time feature and you really as an investor want to think closely about that, because while you get the benefit of deferring the RMD for a few months, you still have to take two that year, and that could presumably bump you into a higher marginal bracket. You want to be thoughtful in that first year, but there's the opportunity to defer.

Benz: One thing you've written about Maria is in those post-retirement, pre-RMD years--so maybe someone retires at age 65 and they have to take their RMDs starting at age 70 1/2--you've talked about that being an opportune time to do a little bit of planning to potentially reduce the balances that are subject to RMDs. How should people approach that decision-making in that time frame?

Bruno: That really is sometimes almost a sweet spot. If you think about it, in your working years, you can direct where your dollars want to go, if it's traditional versus Roth. Once you're retired, your options are a little bit more limited. And certainly, once you have reached age 70 1/2, you are required to take those distributions, so you are really limited in terms of your options.

During that window leading up to 70 1/2, there may be opportunities where your income as a retiree maybe relatively lower. For individuals leaving the workforce today I sometimes call them the RMD generation, because they are leaving the workforce with large traditional deferred balances, and they may not realize as these accounts have grown tax-deferred over the years how large these RMDs could be at age 70.

Couple that with Social Security, and for individuals that defer Social Security, there could be some pretty large tax surprises at that point. The key would be to think strategically leading up to that. There's two options really that you can think about. One would be to accelerate those distributions, to draw from those tax-deferred accounts during those earlier years to meet spending needs, for instance.

The other could be doing series of partial Roth conversions, so taking those distributions and converting to a Roth to create that tax diversification that you may not have. That gives you flexibility later in retirement. So, there's a couple of options during those years where your income may be relatively lower to accelerate income. Now, that is a tough pill for a number of individuals because you're accelerating a tax liability. But you are doing that potentially with the benefit of paying taxes at a lower marginal rate.

Benz: One thing people sometimes struggle with is how to calculate the RMDs, especially if they have multiple accounts. Can we walk through that? Say, I have five different traditional IRA accounts, how would I approach that from the standpoint of RMDs?

Bruno: That's pretty common. Retirees will have monies at different institutions. So, there's a formula that's mandated by the IRS. It's fairly simple. You take the prior year-end balance and there's a formula based upon your age, for instance. Many institutions, Vanguard included, will calculate your distribution requirement for you.

If you have multiple IRAs, you have to calculate what the distribution is from each of those, but you can aggregate those and determine where exactly you want to take the RMD from. If you have money at different institutions, you could take from institution A. You don't have to take it from A, B and C. So, you can actually aggregate those.

Benz: There's an opportunity, too, so, perhaps I have an account that I wanted to scale back anyway. Maybe it's some equity holdings that I'm a little worried about given that the equity market has been on such a run, and I want to take some equity exposure off the table. I could actually concentrate my RMDs on that particular account while leaving the other ones alone?

Bruno: Absolutely. Be strategic if you're taking RMDs, be very strategic and thoughtful in terms of where you take those monies from. It can be used as a rebalancing opportunity. If you are overweighed or you want to reduce risk in certain pockets of your portfolio, it's a great way to do it. You have to take those distributions anyway and those distributions will be subject to income taxes. So, you may as well be strategic in terms of how you do that in terms of managing your overall portfolio risk.

Benz: Maybe even improve my portfolio a little bit along the way?

Bruno: Absolutely.

Benz: Let's talk about another strategy. This is a qualified charitable distribution. That's something that people who are charitably inclined should consider. Let's talk about this maneuver and how specifically I would execute it if I want to give to charity while also meeting my RMD requirements.

Bruno: I mentioned earlier in that there's really limited options once you reach age 70 1/2, but for those that are charitably inclined, this is a great financial planning maneuver. What you're allowed to do is, take the RMD up to $100,000 and give it out right to a charity. The benefit to that is it's actually not even capture into your income at all. You don't get the tax deduction from the charitable contribution, but you don't need to because your income has been reduced. That RMD doesn't factor into the top-line at all. The charity, of course, doesn't have to pay any income taxes on the gifts that they receive as well, too. So, there is a double tax benefit there. The qualified charitable contribution is something to consider for those that are charitably inclined, absolutely.

Benz: Last question for you, Maria, on RMDs is--and this is a high-class problem, but I hear it sometimes from readers--where they will say, I don't need my RMDs entirely to fund my living expenses. In fact, my RMDs may take me over my planned withdrawal from my portfolio. What I should I do? What are the options in that case?

Bruno: That is a good problem to have, right. We talked about the QCD, the qualified charitable distribution. That's certainly one thing. The other thing is, once you take--I often say the mandatory distribution doesn't mean mandatory spend. In fact, we do see that with some of our client activity here at Vanguard, that there is a small cohort of investors that actually are reinvesting those net proceeds into a taxable account. The key there is to invest tax-efficiently. You don't want to invest in investments that generate a lot of current income because then you are potentially increasing your annual tax liabilities there. Broad market index funds tend to be very tax-efficient. Be mindful in terms of how you reinvest those proceeds.

Benz: There's also an opportunity, I know it's probably not all that common, but if either a person or his or her spouse has some earned income, there's also an opportunity to do a Roth IRA, right?

Bruno: Absolutely. Yes. The key there is, as long as you have earned income, you can still contribute to a Roth IRA post 70 1/2, absolutely.

Benz: If all my income is coming from my portfolio and say, Social Security, that wouldn't be an option for me?

Bruno: Correct. It has to be earned income.

Benz: OK, Maria. Thank you so much. As we get into RMDs season, it's great to have these tips.

Bruno: Thank you, Christine.