The tax code and regulations have detailed and specific rules concerning who must take required minimum distributions (RMDs), when they must be taken, and how they are calculated, explains Bob Carlson, editor of Retirement Watch.
But there is no guidance about what a retirement plan owner or beneficiary can do with the RMD. Let's clear up some of the confusion. First and foremost, the required minimum distribution (RMD) rules limit the extent to which an individual can use the tax deferral of an IRA or other qualified retirement plan. The RMD rules dictate when distributions must be made from the retirement plans of certain taxpayers.
The rationale behind the RMD rules is that Congress provided the tax benefits of IRAs and other qualified retirement plans to help individuals save for retirement, but the benefits are to be used primarily for the original account owner’s retirement. They aren’t to be used as estate planning tools, to accumulate wealth protected from income taxes, or to transfer wealth to other individuals. The required minimum distribution rules are established in Internal Revenue Code §409(a). But the tax code section isn’t very specific. The details of the RMD rules are in the IRS regulations issued under §409(a).
How Can I Reinvest My Required Minimum Distribution?
An RMD can be made in either money or property. Once the account owner or beneficiary receives the RMD, there are no restrictions or directions on what the recipient can do with it. Of course, the distribution can be spent on retirement living expenses. It also can be invested in any way the taxpayer’s money outside of qualified retirement plans can be invested. The RMD can be deposited in any type of financial services account.
Some taxpayers want to know if the required minimum distribution can be returned to the IRA, deposited in a Roth IRA, or in some other way contributed to a qualified retirement plan. The answer is that one or more of those actions might be possible, but only in very few cases. Most people who take RMDs won’t be able to return the money to a qualified retirement plan. When the RMD is received, it is included in the gross income of the taxpayer as ordinary income and subject to income taxes.
An RMD can’t be rolled over into another retirement plan in a tax-deferred or tax-free transaction. An RMD also can’t be made directly to a Roth IRA and used to convert the amount from a traditional IRA to a Roth IRA. When the individual wants to convert all or part of a traditional IRA or another retirement account to a Roth IRA, any RMD for the year first must be taken and included in gross income. Only the amount remaining in the traditional IRA or other accounts after the RMD can be converted to a Roth IRA. It might be possible to contribute the RMD amount to a traditional IRA or Roth IRA.
There never has been an age limit on contributions to Roth IRAs. For many decades contributions to traditional IRAs could be made only by those younger than age 70½. But that age restriction was repealed. Now, individuals of any age can contribute to either type of Roth IRA. There are no age restrictions on contributions to 401(k)s. But you must meet the other qualifications for IRA contributions to be able to transfer an RMD amount to an IRA.
The biggest hurdle for most of those subject to RMDs is that an IRA contribution can’t exceed the taxpayer’s earned income for the year. Earned income is income from employment or self-employment. Investment income, annuities, and pensions don’t count. So, unless you have a job or a business that pays your earned income, you aren’t eligible to contribute to an IRA. But someone who does have earned income can make a contribution to an IRA, even if that person also has to take required minimum distributions from the IRA. But the contributions will be subject to the annual limit established by the IRS each year. If the RMD exceeded the annual contribution limit, then the person won’t be able to contribute the entire RMD to an IRA.
There also are income limits restricting those who can contribute to Roth IRAs. Individuals of any level of income can contribute to a traditional IRA. But deductions for the contributions might be limited or eliminated if the individual has “too much” income and is covered by an employer retirement plan.
Reinvesting Required Minimum Distribution: Key Takeaways
- Yes, you can reinvest your required minimum distribution.
- You can reinvest the RMD amount in any type of financial account and any investment offered through that account.
- A few taxpayers might be able to contribute all or part of their RMDs to traditional IRAs or Roth IRAs. But it’s likely that few people subject to RMDs will qualify to make contributions.
- An RMD can’t be converted to a Roth IRA, or rolled over to a Roth IRA or other qualified retirement plan.
We do get a lot of questions about RMDs, especially because there's so little guidance, so look for next week’s issue of Retirement Watch Weekly, in which I’ll be discussing how to properly calculate RMDs.