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4 Financially Smart Ways to Take Money Out of Retirement Accounts

Jan 7, 2025

Discover how planning for required minimum distributions from retirement accounts can help you fund future needs and support loved ones.

Author
Dan Hunt
Dan Hunt, Senior Investment Strategist

Key Takeaways

  • Generally, when you turn 73, the federal tax rules require you to take required minimum distributions (RMDs) from tax-qualified retirement accounts.
  • You can get ahead of RMDs by converting funds from a traditional IRA into a Roth IRA at least five years before you retire.
  • Once your RMDs kick in, you can consider using the funds to contribute to a loved one’s education or donate to charity if you don’t need the RMDs right away. 

Whether you’re approaching retirement or already enjoying it, you might be wondering how to make the most of your required minimum distributions (RMDs). Generally, when you turn RMD Age (currently, age 73)1, the federal tax rules require you to take RMDs annually from certain tax-qualified retirement accounts such as traditional individual retirement accounts (IRAs) and 401(k) plans—whether or not you have an immediate need for that money.

 

For many retirees, this is not welcome news. The extra income you get from these distributions both creates a tax drag on your portfolio’s growth and has the potential to be taxed at higher marginal rates. However, any amount not withdrawn by the due date may be subject to a 25% excise tax.2

 

What if you’re fortunate enough to have other sources of income to support your living expenses in retirement and don’t expect to need your RMDs? Here are four financially smart ways to help manage these distributions.

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  1. 1
    Get ahead of future RMDs with a Roth IRA conversion

    Before you reach RMD age, you may want to consider converting funds from a traditional IRA into a Roth IRA, as it may help you manage future distributions and increase your financial flexibility in retirement. Once your RMDs kick in, you cannot directly deposit RMD funds into a Roth IRA.

     

    If you were to convert your traditional IRA funds to a Roth IRA, you should be prepared to pay taxes on the converted amount. With that said, once these assets are in a Roth account, they can potentially grow tax free. And, if certain conditions are met, withdrawals are not subject to federal income tax. What’s more, since Roth IRAs do not require RMDs during the owner’s lifetime, a conversion may help you reduce the amount held in traditional retirement accounts that will be subject to RMDs, potentially lowering your future distributions. This may help you avoid being bumped into a higher tax bracket when RMDs must be taken. In fact, a Roth IRA conversion can be part of an “income smoothing” strategy that seeks to mitigate the impact of taxes once investors start tapping into their retirement savings.  

     

    Your tax professional can help you understand the tax implications of this strategy and determine whether it makes sense for you. For some investors, a Roth IRA can offer a tax-efficient way to continue saving for future retirement needs.

     

    In addition, to the extent you don’t need the money during your lifetime, the assets you leave in your Roth IRA may continue to potentially grow tax-free. Upon your death, your designated beneficiaries will inherit the Roth IRA and may withdraw funds tax-free if certain conditions are met (though the after-death RMD rules apply and non-spouse heirs typically must withdraw all the funds within 10 years).

     

    Note that a Roth conversion may not be right for everyone, including certain high-income earners who are not eligible to contribute directly to a Roth IRA. There are a number of factors to consider before converting traditional IRA funds to a Roth IRA. These may include whether the costs of paying taxes today outweigh the benefit of income-tax-free qualified distributions in the future. Your retirement timeline can also be an important factor for this consideration; Roth IRA conversions are subject to a five-tax-year holding period, which starts with the tax year in which the conversion contribution is made to the Roth IRA.3 If you’re considering a conversion, you should consult with your tax and legal advisors.

  2. 2
    Help fund a loved one’s education

    Interested in supporting a loved one in their education journey? Once you’ve started taking RMDs, consider using any RMD funds you don’t need to invest in a 529 plan, which you can use for a wide range of educational expenses for the designated beneficiary of the 529 plan, including college and K-12 tuition, meal plans, books, laptops and room and board fees. Withdrawals taken for qualified expenses (up to $10,000 in the case of expenses relating to K-12 education) are free from federal income taxes and generally free from states’ income taxes.

     

    In addition, contributions to 529 plans can be “super funded,” meaning that up to five years’ worth of the annual gift tax exclusion amount can be pooled to allow larger contributions within a single year.4 As with any 529 contribution, these are considered “completed gifts,” which means such contributions may qualify for the annual gift tax exclusion. The assets within the 529 plan are generally excluded from your taxable estate for federal estate tax purposes.5

  3. 3
    Support causes that matter to you

    Donating your RMD money to charity may help you support the causes you care about while potentially lowering your overall tax liability.

     

    If you’re at least 70½, you can make a qualified charitable distribution (QCD) from your IRA directly to the eligible charities of your choice. QCDs can be counted toward satisfying your RMDs for the year, up to IRS limits6 and generally come with no tax costs to you or the charity receiving the donation, potentially helping you give more than you could by donating cash or other assets. 

  4. 4
    Help reduce the risk of outliving your money

    If you’re concerned about outliving your nest egg, consider using your RMD money to purchase an annuity that offers guaranteed income. These products can offer competitive after-tax yields and a minimum level of income for the life of you and/or your spouse, potentially reducing the risk that you will outlive your ability to comfortably fund your retirement. However, not all annuities offer the same benefits. A Morgan Stanley Financial Advisor can help find an appropriate annuity for your needs and goals.

     

    This can provide a sense of security and predictability in retirement, which can be particularly valuable if you are planning on a long retirement.

Work with a Financial Advisor

Planning for RMDs can be challenging, but working with your legal or tax advisors, as well as your Morgan Stanley Financial Advisor, can help guide you through each strategy to potentially help you manage the impact of taxes in retirement and plan for your financial future. By using RMDs strategically, you can help bolster your financial security and support the people and causes you love.

Find a Financial Advisor, Branch and Private Wealth Advisor near you. 

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Footnotes:

1 RMD age” is: (a) 70 ½ (if you were born before July 1, 1949), (b) 72 (if you were born after June 30, 1949, but before 1951), (c) 73 (if you were born after 1950, but before 1960), or (d) 75 for all others .

2 Retirement Plan and IRA Required Minimum Distributions and FAQs, IRS, March 14, 2023, https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs

3 Distributions of converted funds (which were subject to tax at the time of the conversion) before the end of the 5-tax-year holding period are subject to a 10% penalty tax if made before age 59 ½ (unless an exception applies).

4 Up to $90,000 per beneficiary for 2024, assuming no other gifts to that beneficiary during the 5 year period, starting with the year in which the frontloaded 529 contribution is made.

5 However, if the donor dies within five years of making the frontloaded 529 contribution, the estate will generally recapture a portion of the assets for federal estate tax purposes.

6 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000, IRS, Nov. 1, 2023, https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000

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