Retirement accounts like an IRA and 401(k) offer some tremendous advantages when it comes to saving money for retirement. The primary benefit is that contributions are tax deductible, and you won't pay any taxes on your investments in those accounts until you withdraw funds for your retirement.
Unfortunately, you can't defer those taxes forever. Eventually the government forces you to start withdrawing funds from your retirement accounts through required minimum distributions, or RMDs. Most retirees will find their accounts subject to RMDs starting at age 73. If you have an inherited IRA, you may also be subject to RMDs.
While you'll have to make sure you meet the RMD before the end of the year, when you take your RMD is up to you. Many opt to wait until December. And like most personal finance decisions, taking your RMD in December has its pros and its cons.
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Why taking your RMD in December could be a good idea
The biggest benefit of waiting until December to take your RMD is that you give your money more time to compound in the tax-advantaged account. If you're heavily invested in high-yield bonds or big dividend payers, you could get a few extra payments in the account that won't incur income taxes. You can then withdraw the cash paid out by those investments as part of the RMD.
Tax-savvy retirees may use their RMD as a way to pay their taxes. Many retirees have to pay estimated taxes because they don't have withholdings from a paycheck.
Most of the time, you'll be required to make equal payments each quarter. That can be a challenge, especially if you don't know exactly how much you'll owe in taxes for the year. But a clever hack using your RMD can reduce your quarterly estimates to nothing.
Any amount of taxes withheld from your required minimum distribution by your brokerage is deemed to have been paid throughout the year. In other words, it's as if the amount withheld was paid on time each quarter. So, if you withhold enough in taxes from your RMD, that can give you more money to invest in other accounts throughout the year.
Another tax-planning advantage of waiting until December is that you can determine any amount you would like to contribute to charity before taking your RMD. One of the best ways for retirees to contribute to causes they care about is through a qualified charitable distribution, or QCD, from their IRA. The QCD allows you to distribute funds directly from an IRA, and the distribution will count toward your RMD.
It has the advantage of reducing your adjusted gross income, which can affect your Medicare Part B premiums and how much you pay in Social Security tax. What's more, you can still take the standard deduction on top of it.
But it's not all upside for December distributions.
Why taking your RMD in December could be a bad idea
Perhaps the biggest advantage of waiting could also be a disadvantage. On average, waiting to withdraw funds from your retirement accounts until December will result in a bigger balance in your account. That's because you can expect your investments to increase in value the longer they sit in your account. But a bigger retirement account balance means you'll face a bigger RMD next year.
If you plan on reinvesting your RMD, it may be more advantageous to move your investments from your retirement accounts to a taxable account earlier in the year. On average, you'll end up with a lower cost basis on your investments. In effect, this moves your potential gains from being taxed as income to being taxed as capital gains, which receive a preferred tax rate.
What's more, if you pass on the investments to your heirs, they receive a stepped-up tax basis, effectively wiping out the tax on the gains. If those funds remained in your retirement account, younger beneficiaries would have to distribute those funds within 10 years and pay taxes at their income tax rate.
Another inconvenience of taking your RMD late in the year is that you can't make Roth conversions until after you have taken your RMD. Retirees may be looking to take advantage of historically low tax rates right now and make Roth conversions. These also save your beneficiaries from carrying the tax burden if that's a concern. You'll need to complete the conversion before the end of the year, and waiting to take your RMD until December doesn't leave a lot of time.
Lastly, it might make it easier on yourself and your beneficiaries if you get the RMD out of the way early. If something happens and you're hospitalized in December, you might miss taking your RMD.
You can set up your account to automatically distribute your RMD in December, but if you have multiple accounts that you're managing, you likely need some manual oversight. Even worse, if you pass away near the end of the year, you could leave your beneficiaries scrambling to figure out if you took your RMD and how to get the money out before Dec. 31.
Not all of the above factors will be relevant to your particular situation. Be sure to weigh each of them and talk to a tax professional about them, so you can decide whether taking your RMD in December is a good idea for you.
