Saving for retirement in a traditional IRA or 401(k) has its benefits. You get a tax break on the money you contribute to these accounts, and you don't pay taxes on your gains year after year. Rather, those investment gains are tax-deferred until you start taking withdrawals, which you can do without a penalty beginning at age 59 1/2.
But there's a downside to saving in a traditional retirement plan, and it's that eventually, you'll be forced to start tapping your nest egg in the form of required minimum distributions, or RMDs.
RMDs begin at age 73 if you were born before 1960. If you were born in 1960 or later, you don't have to take your first RMD until age 75.
Image source: Getty Images.
But there's a lot of misinformation about RMDs it pays to get to the bottom of before you're on the hook for them. Here's the truth behind three key myths.
1. The only account that doesn't impose them is a Roth IRA
It used to be that Roth IRAs were the only tax-advantaged retirement account that didn't impose RMDs. But effective this year, Roth 401(k)s fall into that category, too. So if your employer plan comes with a Roth savings feature, you may want to take advantage of it. One benefit of a Roth 401(k) over a Roth IRA is that you may be eligible for an employer contribution.
2. They force you to spend your savings
RMDs force you to remove a portion of your savings balance each year, the exact amount of which depends on your age and the amount of money in your account. But it's a big misconception that your RMD has to be spent.
The only requirement with RMDs is to get that money out of your IRA or 401(k). Beyond that, what you do with those funds is up to you. You could invest them in a taxable brokerage account, open a CD, or put the money into your savings.
3. They automatically create a tax burden for you
Since traditional IRA and 401(k) plan withdrawals are considered taxable income, the same applies to RMDs. But that doesn't mean you'll be stuck with an increased tax burden.
If you donate your RMD to a registered charity, it won't count as taxable income, similar to how charitable donations can exempt income from taxes for non-retirees. If you're in a position where you've saved a lot and don't need to spend your RMDs, consider arranging for those distributions to go to different charities you care about directly. You can save on taxes while doing something you feel good about.
RMDs in retirement can be a pain, so you may want to save at least some of your money in a Roth IRA or 401(k) to avoid them. Or, you may want to do a Roth conversion at some point before your career comes to an end. But if you're on the hook for RMDs, it's important to know the rules inside and out -- and avoiding believing bad information.
