If you plan to use RMDs to pay for current expenses, it often makes sense to have a budget in retirement. Going through the budgeting process can help you estimate living expenses, manage your cash flow, and determine if you'll need to use your RMDs to fund your retirement lifestyle.
2. New investments
For some retirees, Social Security benefits and other income may cover your expected expenses. Remember, even though you may not need RMD monies to fund your retirement spending, you're still required to take them out of your applicable retirement accounts. Although your RMD can't be reinvested back into an IRA, you can put money into taxable brokerage accounts and then reinvest your RMD proceeds according to a strategy that fits your needs.
3. Wealth transfer to a loved one
There are several tax-smart ways to pass money to your loved ones. If you'd like to help give someone's education a head start, consider using the money you take for your RMD to fund a 529 college savings account. Another option is to convert some of your traditional IRA assets to a Roth IRA, which can be inherited without as many income tax implications. With this "Roth conversion" strategy, you'll pay income tax on the amount you convert, but you'll no longer have to worry about RMDs on that amount, because RMDs are not required during the lifetime of the original account owner in a Roth IRA.
Remember, if you're already over 72, you will have to take an RMD for the current tax year before you can convert to a Roth IRA—that is, Roth conversions do not satisfy the RMD requirement, although you can use all or part of the RMD to pay the taxes due from the conversion. On the other hand, if you anticipate that your heirs will be in a much lower tax bracket than your own, or if you plan to leave IRA assets to charity, it may not make sense to convert. Also note that Roth conversion rules may change in the future, so you'll want to keep up on the latest tax reform legislation.
While distributions from Roth IRAs are generally not subject to federal or state income taxes during the lifetime of the original owner, the balances are still subject to estate tax, so it is important to plan accordingly. Since there are other ways to transfer money to heirs, such as trusts and gifting, consult an estate planning advisor before making any decisions.
4. Charitable donations
If you have to satisfy an RMD and you would also like to make a gift to charity, then consider a qualified charitable distribution (QCD).
A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. Once you've reached age 72, the QCD amount counts toward your RMD for the year, up to an annual maximum of $100,000. It's not included in your gross income and does not count against the limits on deductions for charitable contributions. These can be significant advantages for certain high-income earners.
Due to changes enacted by the Tax Cuts and Jobs Act, a number of retirees may now choose to take the standard deduction when filing taxes ($12,550 for singles; $25,100 for couples in 2021) rather than itemize. For those people, QCDs may be a useful alternative because they do not rely on itemization as might be the case for other large charitable contributions.