Retirement—the golden age we aspire to reach, when we can finally enjoy our hard-earned savings. Amidst all the excitement of golden sunsets and strolls, however, a financial milestone can catch many retirees off guard: required minimum distributions (RMDs). Today, we'll dive into RMDs—from the essentials to their more intricate elements—to help you make more informed decisions in this respect.

Understanding RMDs: the basics

RMDs are IRS-mandated withdrawals from tax-advantaged retirement accounts such as 401(k)s and IRAs. These withdrawals kick in the year you turn 73 (75, beginning in 2033). You must take your first RMD by April 1st of the year after you turn 73; for subsequent years, you must do so by December 31st.

What’s the purpose of RMDs?
If you’re wondering why RDMs are mandated, know this policy is in place so that the IRS can collect taxes on these accounts—as all contributions you’ve made are tax-deferred, using pre-tax money. With this in mind, RMD rules apply to all employer-sponsored retirement plans including 401(k), 403(b), profit-sharing, and 457(b) plans. The mandate also applies to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs as well as Roth IRA beneficiaries.

How to calculate RMDs
The amount you’re required to withdraw is calculated based on the account balance and a life expectancy factor. The IRS provides uniform lifetime tables to help with this calculation, taking into account your age and the account balance at the end of the previous year. You’ll notice that RMD percentages grow over time until the RMD eventually depletes the account. This is by no means an accident, as these are not intended to serve as legacy accounts: meaning that while you may have some leftover investments for beneficiaries, the purpose of these accounts is to fund your retirement.

What happens if you don’t take RMDs?
Failing to take the required minimum distribution can lead to hefty penalties—25% of the amount you should have withdrawn, to be exact. This penalty can drop to 10% if you rectify the situation in a timely fashion by withdrawing the required amount and submitting an updated tax return before the deadline. Furthermore, you can seek help from the IRS to waive this penalty—but you'll need a good reason such as a severe illness or the assertion that you had received lousy advice from a tax preparer or IRA sponsor. The point here is that you can lose a significant chunk out of your nest egg if you fail to stay on top of your RMDs.

Can I withdraw more than the requirement?
If your circumstances dictate you withdraw more than the minimum amount, go for it! However, remember this may involve tax implications as your withdrawal will be taxed as ordinary income (i.e., the same rate as any wages, interest income, or short-term capital gains).

Taking your RMD in annual distributions vs. installments

One key decision retirees face is how exactly to receive their RMDs: in one annual lump sum or via regular installments throughout the year. Let's explore the pros and cons of each approach.

Annual RMDs
With an annual lump sum, you take the full RMD at any point during the calendar year (or by April of the following year if it’s the first year you’re required to do so). One of the biggest advantages of the annual lump sum option is, quite frankly, simplicity. Taking your RMD in a single annual withdrawal is a one-and-done affair, reducing any administrative burden. An annual withdrawal also allows for a strategic approach to investment; in theory, you can time your withdrawal with market highs or lows, potentially optimizing your overall returns.

Timing the market, however, is one of the biggest risks of taking an annual lump sum as accurately doing so is incredibly difficult. If the market is down when you take your RMD, you might lock in losses. Conversely, if it's up, you could miss out on further potential gains. The other issue with taking an annual lump sum is that some individuals may find it challenging to effectively manage a large amount of money over the course of a year; discipline and planning are crucial to ensure funds last.

RMD installments
While an annual installment may prove easier from a one-and-done perspective, regular installments throughout the year are often simpler from a budgeting standpoint: providing a consistent income stream and making financial planning more manageable. You can establish installments on a quarterly, monthly, or even twice-monthly basis. The latter approach mirrors the ubiquitous twice-monthly paycheck, paving the way for a smoother transition into retirement if you’re accustomed to the same.

By spreading your RMDs across the year, you also engage in reverse dollar-cost averaging. While dollar-cost averaging is an investment strategy that seeks to limit market volatility impacts by investing the same amount at set intervals, the reverse—selling a set amount at fixed intervals—can do the same.

It’s important to note that while dollar-cost averaging (and its reverse) may help mitigate market risks, it doesn't eliminate them entirely; you're still exposed to market fluctuations. Also consider administrative hassles, as managing periodic withdrawals is sometimes burdensome as it requires more attention to detail and coordination with financial institutions.

In-kind transfers

Some retirees must make withdrawals to support themselves in retirement while others have more flexibility. For those in the latter group, in-kind transfers are a strategic RMD option. Remember that distributions exist so the government can collect taxes on the same; an in-kind transfer allows the government to collect taxes without any need for you to sell your investment.

What is an in-kind transfer?
To take an RMD, you must typically sell assets to create enough cash to cover the RMD and then distribute that cash. In-kind transfers allow you to transfer or withdraw the asset itself; this involves moving assets from your retirement account to a taxable brokerage account without selling them (note you cannot roll them into a tax-deferred account).

To complete an in-kind transfer, you first choose which specific assets to transfer (e.g., stocks, bonds, or other securities held in your retirement account). You then work with your financial institution or financial advisor to initiate the transfer, and assets move from your retirement account to your taxable brokerage account without being sold. While the transfer itself isn’t a taxable event, you’ll still owe taxes on the value of the transferred assets (with this tax liability based on their current market value).

In-kind transfers allow you to keep your investment positions intact, which is especially beneficial if you believe the market will rebound after a downturn. Additionally, by choosing specific assets to transfer, you can strategically manage your tax liability; this may involve selecting assets with lower capital gains or losses.

While in-kind transfers are often a smart strategy, associated fees—such as transaction costs—may impact their overall effectiveness. You should also keep in mind that in-kind transfers can be more complex than traditional cash withdrawals. With all of this in mind, consult with your financial advisor to ensure you fully understand the process and related implications.

The cash bucket strategy

Historically speaking, 2022 was not a good year for stocks and bonds. Consequently, many retirees took RMDs after their retirement portfolios took significant hits: leading many to question whether they’d go on to outlive their savings.

This is precisely where cash bucket strategies come into play; if done correctly, they can help retirees better meet their income needs and perhaps feel more confident they can withstand future bear markets.

How the cash bucket strategy works
The cash (or “retirement”) bucket strategy involves splitting your income sources into various buckets (often three) based on when you’ll need the money: in this example, we’ll use immediate, intermediate, and long-term buckets for this purpose.

Each bucket includes assets with varying levels of risk:

Your immediate bucket is all about liquidity and consists of cash or cash equivalents—such as money market accounts, CDs, or short-term bonds—to cover near-term expenses. As the money in this bucket begins to deplete, the idea is to replenish funds with interest income, dividends, and investment returns from the other two buckets.

The middle bucket covers expenses from years 3 through 10 of retirement; money in this account should therefore continue to grow with inflation in the absence of high-risk investments. Investments in this bucket often include longer-term CDs, REITs, preferred stocks, and bonds, and returns can be used to replenish your short-term bucket as needed.

Your third bucket, designed to cover expenses in year 10 and beyond, should include investments that mimic historical stock market returns and are thus riskier assets (albeit diversified) such as stocks: giving this bucket time to rebound from market slumps and generate the best possible returns. Income generated from these investments can help retirees top off their intermediate bucket.

Cash bucket strategy benefits
By allocating enough funds in the cash bucket to cover upcoming RMDs and other planned near-term expenses, there’s no need to worry about selling assets from the third bucket at an inopportune time to meet financial obligations. This strategy thus gives you peace of mind and reduces anxiety related to market fluctuations, especially if you prefer to take an annual/lump sum RMD.

Cash bucket strategy disadvantages
The biggest downside of the cash bucket strategy is that you must have sufficient assets to ensure each retirement bucket isn’t stretched thin. This approach may also require more work on your part to ensure the strategy aligns with your investment style and risk tolerance.

Cash bucket strategy considerations
If you choose to implement the cash bucket strategy, you’ll want to regularly reassess and rebalance your cash bucket to ensure it aligns with your near-term financial needs. You’ll also want to separate your cash bucket from your emergency fund, as the former is specifically designed to cover planned near-term expenses while the latter is for unforeseen circumstances. As with any financial strategy, consult with your financial advisor prior to implementation. He or she can help tailor the approach to your individual financial goals, risk tolerance, and market outlook.

Key RMD takeaways

Mastering the art of required minimum distributions is an essential component of a successful retirement strategy. Whether you opt for annual withdrawals, regular installments, or explore the strategic possibilities of in-kind transfers, staying proactive and well-informed will help you make the most of your golden years. Remember that retirement is not just about the destination; it’s about enjoying the entire journey with financial peace of mind.

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FAQs

Since the government simply wants to make sure you’re paying taxes on this money, you can spend or reinvest your RMD withdrawals as you see fit (other than reinvesting the money in a tax-advantaged account). That said, you may be able to reinvest your RMD in a Roth IRA provided you’ve earned income either equal to or greater than the amount reinvested (and are eligible based on account income limits).
As individual ownership is required for retirement accounts, you cannot take an RMD from your spouse’s account to satisfy yours—as doing so would lead the IRS to claim you failed to fulfill your RMD requirement and then require you to pay the 25% penalty. Despite what you may think, it’s not uncommon for married couples to miss this distinction as so many financial assets are held jointly.
Feel free to check out related RMD strategies, knowing a commonly used approach is to convert some RMD-mandated retirement account savings into a Roth IRA (known as a “Roth IRA conversion”). While these accounts don’t include any RMD mandates over the span of your lifetime, some drawbacks to this strategy do in fact exist; the largest being that you’ll need to pay taxes on the amount of money converted, as you’re moving pre-tax money. Unfortunately, these conversions are therefore often expensive.

Mastering RMDs: Navigating the Essentials