Is it possible to reinvested your required minimum distributions (RMDs) from a traditional IRA in a Roth IRA if you are eligible for one based on your income and don’t need them for living expenses?
This is due to the fact that you can fund your individual retirement account (IRA) with any available cash source; nonetheless, you must still be aware of the contribution caps and earned income requirements.
Understanding Required Minimum Distributions (RMDs)
As you approach retirement, you’ll need to start withdrawing funds from your traditional IRA and other retirement accounts to avoid penalties. These mandatory withdrawals are known as Required Minimum Distributions (RMDs). The age at which RMDs begin depends on your birth year:
- Born before 1951: 70.5 years old
- Born between 1951 and 1959: 72 years old
- Born in 1960 or later: 73 years old
The RMD amount is calculated based on your account balance and your life expectancy. You must withdraw this amount each year, regardless of whether you need the money or not. Failure to do so can result in a hefty penalty of 50% of the undistributed amount.
Roth Conversions and RMDs: Two Separate Processes
Many investors consider converting their traditional IRA to a Roth IRA. Roth IRAs offer several advantages, including tax-free withdrawals in retirement and no RMDs. However, it’s important to understand that a Roth conversion and an RMD are two distinct processes.
Here’s why a Roth conversion doesn’t count as an RMD:
- RMDs are mandatory withdrawals from traditional IRAs, while Roth conversions are voluntary transfers of funds from a traditional IRA to a Roth IRA.
- RMDs are taxed as ordinary income in the year they are withdrawn, while Roth conversions are taxed on the amount converted at your current ordinary income tax rate.
- RMDs are calculated based on your account balance and life expectancy, while Roth conversions are not subject to any specific calculation.
Can You Convert Your RMD to a Roth IRA?
No, you cannot directly convert your RMD to a Roth IRA. The IRS mandates that you take your RMD for the year before you can perform a Roth conversion. This is because the RMD amount is considered a taxable distribution and is not eligible for conversion.
Investing Your RMD: Options Beyond a Roth Conversion
If you don’t need your RMD for living expenses, you have several options for reinvesting it:
- 529 Savings Plan: This plan allows you to save for future education expenses, such as tuition, fees, and room and board.
- Mutual Funds: These funds pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets.
- Stocks: These represent ownership shares in a company.
- Bonds: These are debt instruments issued by governments and corporations.
The Benefits of Roth Conversions
While a Roth conversion doesn’t count as an RMD, it can offer several benefits:
- Tax-free withdrawals in retirement: Unlike traditional IRAs, Roth IRAs allow you to withdraw your contributions and earnings tax-free in retirement.
- No RMDs: You are not required to take RMDs from a Roth IRA during your lifetime. This allows your money to grow tax-free for as long as you need it.
- Potential tax savings: If you expect to be in a higher tax bracket in retirement, converting your traditional IRA to a Roth IRA now can save you money on taxes in the future.
Key Considerations Before Converting to a Roth IRA
Before you decide to convert your traditional IRA to a Roth IRA, consider the following:
- Your current and future tax bracket: If you expect to be in a lower tax bracket in retirement, it may not make sense to convert your traditional IRA to a Roth IRA now.
- The size of your traditional IRA: If you have a large traditional IRA, converting it to a Roth IRA could result in a significant tax bill.
- Your investment time horizon: If you have a long time horizon, the tax-free growth of a Roth IRA can be very beneficial.
Understanding the difference between RMDs and Roth conversions is crucial for making informed decisions about your retirement savings. While a Roth conversion doesn’t count as an RMD, it can offer significant tax advantages in the future. Carefully consider your individual circumstances before making a decision.
Frequently Asked Questions
What happens if I don’t take my RMD?
If you fail to take your RMD, you will be subject to a penalty of 50% of the undistributed amount.
Can I use my RMD to contribute to a Roth IRA?
No, you cannot directly use your RMD to contribute to a Roth IRA. However, you can take your RMD and then use the money to fund a Roth IRA contribution.
What are the income limits for Roth IRA contributions?
The income limits for Roth IRA contributions vary depending on your filing status. For 2023, the income limits are as follows:
- Single, head of household, or married filing separately (and you didn’t live with your spouse at any time during the year):
- Less than $138,000: $6,500 ($7,500 if age 50 or older)
- $138,000 to $152,999: A reduced amount
- $153,000 and above: Zero
- Married filing jointly or qualifying widow(er):
- Less than $218,000: $6,500 ($7,500 if age 50 or older)
- $218,000 to $227,999: A reduced amount
- $228,000 and above: Zero
What are the benefits of a Roth IRA over a traditional IRA?
Roth IRAs offer several benefits over traditional IRAs, including:
- Tax-free withdrawals in retirement: Unlike traditional IRAs, Roth IRAs allow you to withdraw your contributions and earnings tax-free in retirement.
- No RMDs: You are not required to take RMDs from a Roth IRA during your lifetime. This allows your money to grow tax-free for as long as you need it.
- Potential tax savings: If you expect to be in a higher tax bracket in retirement, converting your traditional IRA to a Roth IRA now can save you money on taxes in the future.
Additional Resources
- IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs): https://www.irs.gov/publications/p590b
- IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs): https://www.irs.gov/publications/p590a
- Investopedia: Roth IRA vs. Traditional IRA: Which Is Right for You? https://www.investopedia.com/articles/retirement/08/roth-ira-vs-traditional-ira.asp
- NerdWallet: Roth IRA vs. Traditional IRA: What’s the Difference? https://www.nerdwallet.com/article/investing/roth-ira-vs-traditional-ira
By understanding the difference between RMDs and Roth conversions, you can make informed decisions about your retirement savings. While a Roth conversion doesn’t count as an RMD, it can offer significant tax advantages in the future. Carefully consider your individual circumstances before making a decision.
Investing an RMD Into a Roth IRA
If you are 50 years of age or older, you can contribute up to $7,000 per year to an IRA for the 2022 tax year. In 2023, that limit goes up to $7,500. That cap applies to all of your IRAs, both traditional and Roth. (The limits are $1,000 less for anyone under age 50. ).
The Internal Revenue Service (IRS) mandates that you have sufficient earned income to cover your annual Roth IRA contribution; however, your contribution does not have to come from your paycheck.
You could put all of the money into your Roth IRA if your RMD was less than $7,000. However, if you made a $4,000 contribution to another IRA in the same year, you could only put $3,000 of your RMD into a Roth IRA.
The direct conversion of RMDs to a Roth IRA is prohibited by the IRS for account holders.
Also, there are Roth IRA contribution guidelines that depend on your income and status as a tax filer. Reduced contributions are allowed if your modified adjusted gross income (MAGI) falls within the Roth IRA phase out range. If your MAGI is more than the maximum allowed by your filing status, you are not eligible to make any contributions.
Here’s a rundown for the 2022 and 2023 tax years:
| Roth IRA Income Limits | ||||
|---|---|---|---|---|
| Filing Status | 2022 MAGI | 2022 Contribution Limit | 2023 MAGI | 2023 Contribution Limit |
| Married filing jointly or qualifying widow(er) | Less than $204,000 | $6,000 ($7,000 if age 50 or older) | Less than $218,000 | $6,500 ($7,500 if age 50 or older) |
| $204,000 to $213,999 | A reduced amount | $218,000 to $227,999 | A reduced amount | |
| $214,000 and above | Zero | $228,000 and above | Zero | |
| Single, head of household, or married filing separately (and you didn’t live with your spouse at any time during the year) | Less than $129,000 | $6,000 ($7,000 if age 50 or older) | Less than $138,000 | $6,500 ($7,500 if age 50 or older) |
| $129,000 to $143,999 | A reduced amount | $138,000 to $152,999 | A reduced amount | |
| $144,000 and above | Zero | $153,000 and above | Zero | |
| Married filing separately (and you lived with your spouse at any time during the year) | Less than $10,000 | A reduced amount | Less than $10,000 | A reduced amount |
| $10,000 and above | Zero | $10,000 and above | Zero | |
Avoiding RMDs
The process of converting a traditional IRA into a Roth IRA, known as a Roth IRA conversion, is an option. Once the money is in a Roth IRA, you won’t be required to take annual withdrawals because Roth IRAs don’t have RMDs.
Recall that while initial contributions to a Roth account are not tax deductible up front, qualified withdrawals made in retirement are, and there are no required minimum distributions (RMDs) during the owner’s lifetime.
But the conversion of a Roth IRA is taxable, and there may be a sizable tax liability. You must pay those deferred taxes on the converted funds since you were given a tax deduction for your traditional IRA contributions.
To find out if a conversion would be financially advantageous for you, it’s a good idea to consult a tax expert as there are other aspects to take into account in addition to the RMD issue. For instance, transferring funds from a traditional IRA to a Roth could also cause you to enter a higher tax bracket, raising your annual marginal tax rate.
In the event that you choose to convert to a Roth IRA, don’t forget to take a final RMD from your traditional IRA for the conversion year. That is required because, in that year, the traditional IRA was still in place.