Reinvesting Your RMD in Retirement? Here's What You Need to Know

Is the IRS now forcing you to take money out of your IRA? If you're going to be 73 years old (or older) at any point this year and the IRA in question isn't a Roth account, it will be. They're called required minimum distributions, in fact, or RMDs. These withdrawals ensure the federal government eventually collects the taxes you've been able to defer until now. As for the size of your distribution, that depends on the value of your account and your age -- the older you are, the bigger your required distributions become.

Whether this will be your first RMD or if you've now received several, there are some things about required minimum distributions you might want to know...particularly if your plan is to reinvest this money.

Where to invest $1,000 right now? Our analyst team just revealed what they believe are the 10 best stocks to buy right now. Learn More »

But first things first.

RMD logistics

The IRS provides a mathematical formula for you to figure out your yearly RMD, although most retirees won't need to know or use it. Your brokerage firm, retirement plan administrator, or IRA's custodian should be able to determine this minimum distribution for you. All you need to do is ask; some will even let you know without asking.

As for how it's calculated by whoever's crunching the numbers, required minimum distributions are ultimately based on the value of the retirement account in question as of the end of the previous year. But again, the proportion of your IRA that must be withdrawn also gets bigger as you get older. (Note that if you have multiple retirement accounts, you'll likely get an RMD notification from each broker or custodian. Be sure to combine these totals. Just bear in mind you have the option of taking this total RMD amount from a single IRA. The IRS only cares about the total amount of distribution you take. It doesn't care about which particular retirement account(s) it comes from. The exception is 401(k) accounts that are still being funded rather than being converted into rollover IRAs. Each of these accounts should make their own yearly RMD.)

There's a deadline to consider, too. With the exception of your first one, RMDs need to be completed by the end of the calendar/tax year. Otherwise you face a potential penalty. Your very first required minimum distribution, however, doesn't need to be done until April 1 of the year after which you turn 73. Just know that waiting until then will mean taking two taxable RMDs in the same tax year, potentially bumping you up into a higher tax bracket.

These technical details are secondary though. Your chief concern is reinvesting your required distributions the best way possible.

Read this before reinvesting your RMD

There are four key details you'll want to know before making any decisions regarding the reinvestment of your required distribution.

1. The distribution doesn't have to be a cash withdrawal

Most IRA distributions -- required or otherwise -- are completed in the form of cash, often following the sale of an asset. And that's fine.

Cash distributions aren't your only option, however. If you're happy with your portfolio's current allocation and don't want to sell anything, you can take what's called an "in-kind" distribution of a particular stock, bond, fund, or other asset with a clear market price. This might take more explicit instruction and, perhaps, an extra day or two to complete, but it also circumvents the need to sell anything and then reinvest those proceeds outside the IRA.

And if you're wondering how an in-kind distribution of assets satisfies the IRS's RMD rules, the transfer is assigned a monetary value the day it's completed. Again, your broker, custodian, or retirement plan administrator can supply you with the specific dollar value for this distribution once it's made.

2. The timing of the RMD could matter

While one year's RMD figure is fixed by virtue of it being based on the IRA's value as of the end of the prior year, the value of your retirement account isn't. It will still ebb and flow throughout the following year. If you'd like to leave as much in the IRA as possible, it makes sense to complete your required distribution at a point when your holdings are at relatively high prices. That means you can sell or transfer a smaller number of shares and still meet your RMD obligations.

Just don't get too picky with such a plan. Short-term market timing is generally difficult to do well, so much so that the strategy could backfire.

3. Some people will be able to put money back into an IRA

It's also possible to reinvest at least some of your required minimum distribution after first putting it back into an IRA -- presuming you're eligible.

This is an option that won't apply to most retirees. Retirement account contributions can only be made using earned, work-based taxable income, after all. If your retirement income only consists of pensions, Social Security, and the like, you won't be able to contribute any new money to an IRA.

If you're earning taxable income at a job, however, you are allowed to make the usual contributions to traditional and Roth IRAs as well as to 401(k) plans, even while you're taking required minimum distributions.

There's no means of making direct dollar-for-dollar transfers of RMDs back into tax-deferring retirement accounts, to be clear. Nor would you want there to be; the odds of one year's required minimum distribution being the exact same amount of money you'd want (or be allowed) to contribute to an IRA is nil anyway. But, the IRS doesn't mind if it's your required distribution that makes it possible for you to put new money back into a retirement account. It only cares that you adhere to its IRA contribution limits as well as its RMD rules.

4. Reallocate with the taxability of your accounts in mind

Finally, to date you've not needed to worry about the tax consequences of any of your IRA's holdings. Dividends, capital gains, interest payments -- none of them are taxable as long as they remain within the retirement account. Nothing is taxed until, and unless, it's withdrawn from the account in question, and then it's the entire value of that withdrawal that's taxed like ordinary income.

This obviously won't be the case with RMD money reinvested outside an IRA. These investments will be immediately and perpetually subject to taxation.

So, allocate accordingly. If you'd still like to minimize your current taxable income, for example, lean toward stocks that are more likely to produce capital gains in the now-taxable brokerage account that will be receiving your RMD. If, instead, you'd like some reliable income and don't mind the additional annual tax bill, buy dividend-paying stocks with your RMD funds.

Here's something else to consider: You've not received any tax benefit from investment losses suffered in your retirement account. You will, however, be able to deduct some investment losses from your taxable income when it happens in a conventional brokerage account. If you don't mind taking risks that make such losses a possibility for you, there's a case to be made for making your highest-risk trades with RMD money and using the remainder of your retirement account's balance for the safer stuff that isn't as likely to lose ground.

The $22,924 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $22,924 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

View the "Social Security secrets" »

The Motley Fool has a disclosure policy.