You’ve spent much of your working life saving for retirement. Now that you’re about to start drawing on that account or taking distributions, how can you stretch your savings?
Here’s what you need to know:
There are many IRS rules governing distributions. These are the key ones:
You can, of course, withdraw more than your RMD, but you may want to consider leaving as much of your retirement savings in your account as possible. This way, your remaining savings have the opportunity to continue growing.
If you want to avoid RMDs, you can roll some or all of your retirement plan account into a Roth IRA, which is not subject to RMDs over your lifetime.
You have three options, depending on the terms of your plan:
Move the money into a rollover IRA.
By rolling your retirement savings into an IRA, you can continue to enjoy tax-advantaged growth potential. Roth 401(k) and 403(b) accounts can be rolled into Roth IRAs. Non-Roth accounts can be rolled into traditional IRAs or Roth IRAs. You’ll be responsible for any unpaid taxes on the taxable portion of a Roth IRA rollover. Unlike traditional IRAs, Roth IRAs are not subject to required miniumum distributions over the owner’s lifetime.
With rollover IRAs, you can also:
- Avoid potential taxes and penalties you might owe if you cashed out.
- Consolidate multiple retirement accounts.
- Choose from a potentially wider range of investment options than your employer’s plan offered.
- Gain greater control over withdrawals than your employer’s plan might offer. (Some employer plans only allow lump-sum distributions; withdrawals from IRAs can be taken over time.)
Leave the money in your plan.
Even if you have retired, you may still be able to keep your money in your retirement plan if the balance is over $5,000. Your investments (minus required distributions) will continue to have the opportunity to grow tax-deferred.
Consider this if you’re happy with your plan’s provider and the choice of investments. Keep in mind that you’ll still be subject to the rules of your former employer’s plan and will need to begin taking minimum distributions after you turn 70-1/2.
Cash out with a lump-sum distribution.
Although taking your retirement nest egg all at one time may look attractive, it may bump you into a higher tax bracket.
That means you may pay a higher percentage of your retirement savings in taxes with a one-time payment than you would if you were taxed over time for smaller distributions. In addition, you lose the potential for your retirement savings to continue growing in value tax-deferred.
Remember: If you take a distribution, you may have to pay a 10% early withdrawal penalty to the IRS unless you qualify for an exception. In addition, your employer is required to withhold 20% of the distribution for federal income taxes.
That said, a one-time lump-sum distribution may make sense for retirees who:
- Have other assets to live on and want to spend their retirement money for a specific purpose
- Can benefit from special tax treatment for people born before 1936 who can still take advantage of special 10-year forward-averaging and capital gains treatment on lump-sum payments
For more information, see Rollovers.
Tax implications of distributions
Since taxable retirement distributions are considered income, they are subject to prevailing IRS income tax rates.
If you elect to take a bigger distribution than required by law, you may push yourself into a higher tax bracket, with a greater percentage of your distribution being eaten up in taxes.
By taking only the required minimum distribution, you lower your tax exposure and give your retirement savings more time for potential growth.
Qualified distributions from Roth accounts are tax-free and do not increase your taxable income.*
You can invest required minimum distributions taken from your retirement account in a nonretirement account as a way to stretch the financial benefit. However, keep in mind that any income may be taxable.
What you can’t do is roll any income from a required minimum distribution into another IRA or retirement plan.
Here’s a tip: Many retirees leave the work force with savings in both after-tax and tax-deferred accounts. If you have enough income from after-tax accounts and other sources, you may want to save the distributions from your tax-deferred accounts for last.
Talk to your financial professional before making final distribution plans.
* Withdrawals from Roth accounts are tax- and penalty-free if the account was established at least five years before, and if the participant is at least 59-1/2 years old, has died or is disabled. For nonqualified distributions, earnings are taxable and may be subject to a 10% early withdrawal penalty.