If you saved for retirement using a traditional IRA, 401(k), 403(b), 457(b), or SEP IRAs, you're likely aware of RMDs: required minimum distributions. Depending on the year you were born, you're probably fulfilling your RMD requirements already, or will begin taking RMDs at age 73 or 75 (if you were born in 1960 or later).
RMDs are mandatory withdrawals from retirement accounts that must start by April 1 of the year following your 73rd or 75th birthday. Failure to take an RMD can lead to a hefty tax penalty. But what if you don't need that money immediately and want to put it somewhere it can continue growing?
If you're reinvesting your RMDs, here's what you need to know.
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The first step is to consider cash flow
When considering reinvesting, double-check your annual budget to ensure you're not cutting yourself short. Don't forget to factor in irregular expenses, like HOA fees, insurance premiums, home and vehicle maintenance, property taxes, and pet expenses.
You'll probably owe taxes
Uncle Sam wants his piece of the pie, no matter where or how you reinvest an RMD. Because you didn't pay taxes on the income when it was initially invested, it will be due in the tax year the RMD is made, even if you roll it directly over to another investment account.
Options are fairly limitless
Maybe you've had more time to study investment options or become more conservative now that you're not earning a regular income. In either case, your options are wide open. Your money can go wherever you believe will best serve your needs. For example, you can reinvest funds into mutual funds, stocks, bonds, or taxable brokerage accounts, where the money can grow and provide dividend income.
If you don't have one already, now may be a good time to meet with a retirement advisor who can help you understand each option's pros and cons. The important thing is to carefully consider your investment goals, risk tolerance, and how long you predict the funds will remain in the new account.
Diversification still matters
Even if you can't foresee a day when you'll need the money you're reinvesting, protecting your assets by diversifying the new investments is essential. Diversification is key to helping manage portfolio risks.
You may come to appreciate bear markets
A bear market is typically defined as a drop of 20% or more in a major stock market index from its recent high. Many factors, including an economic recession, geopolitical tensions, and rising interest rates, can trigger bear markets. While some investors dump stocks when things start to go south, hanging in there can be advantageous. A bear market gives you the opportunity to buy low and watch your assets grow in value as the market recovers.
One note about bear markets during retirement: Consider stowing enough cash in a separate account to cover living expenses so you aren't tempted to sell assets while portfolio values are at rock bottom. The goal is to take advantage of low prices to plump your portfolio while you can. The fact that you've decided to reinvest RMDs indicates that you don't believe you'll need the money to cover bills.
However, an unexpected issue, such as a higher-than-expected medical expense or natural disaster, could make it challenging to stick with the plan, and having an alternate source of funds could help.
Treat your new investments just as you treated your old
Anything you reinvest in needs a little babysitting. For a long-term investor, that means regularly reviewing your new strategy to ensure it continues to meet your needs. For example, if you decide to go for broke and make riskier investments, switching that strategy is OK if you find it's not working for you.
Consider yourself fortunate if you can reinvest an RMD rather than use it to pay bills. Once you've made the tough decisions, you can sit back and (hopefully) watch your money grow.
