Are you approaching retirement age and wondering how to maximize your retirement savings? If you have a tax-deferred retirement plan like a traditional IRA or 401k, you may be required to take required minimum distributions (RMDs) once you turn 73 years old.
But what if you don’t need the money for living expenses and want to continue growing your retirement savings tax-free? Can you use your RMD to fund your Roth IRA?
The short answer is yes, you can use your RMD to fund your Roth IRA. However, there are some tax considerations you need to be aware of.
Once you turn 73 years of age, you’re required to take required minimum distributions (RMDs) from your traditional IRA and 401k each year. The amount you’re required to withdraw is based on your account balance and your life expectancy. You’ll need to calculate your RMD each year to avoid penalties, and you can do so using the RMD table here.
A Roth IRA has no RMD rules. Account owners of a Roth IRA can keep their money compounding tax-free as long as they’re alive.
It’s important to note that RMDs can’t be directly rolled over into a Roth IRA. However, you can use the money you withdraw from your RMD to fund your Roth IRA, after paying taxes on the amount withdrawn.
When calculating your RMD, you’ll need to use the appropriate IRS life expectancy tables to determine your distribution period. If you have multiple traditional IRAs, you’ll need to calculate the RMD for each account separately, but you can take the total distribution from one or more of the accounts.
At what age does RMD start?
RMDs (Required Minimum Distributions) start once you turn 73 years old and you must take distributions each year until your account is fully liquidated.
You must take your RMD by December 31st each year. However, your first RMD can be delayed until April 1st of the year following the year you turn 73.
Are there penalties for not taking an RMD?
If you fail to take your RMD, you’ll be subject to a penalty of 50% of the amount you should have withdrawn. This penalty can be avoided by taking your RMD by the deadline, which is usually December 31st of each year.
Can You Use RMDs to Fund Roth IRAs?
Yes, you can use your RMD to fund a Roth IRA. However, RMDs do not count as earned income and you’re required to pay income taxes on the amount you withdraw before you can put it into a Roth IRA.
RMD is not earned income
You can only contribute to a Roth IRA if you have earned income. RMDs do not count as earned income, so you cannot contribute your entire RMD to a Roth IRA if you didn’t earn enough money to cover the amount you want to contribute. You can only contribute up to the annual contribution limit, which is $7,500 in 2023 if you’re age 50 or older.
For example, let’s pretend your RMD for 2023 is $7,500, which is conveniently the contribution limit of a Roth IRA for the year. However, you only made $3,000 in earned income this year. Therefore, you will only be able to contribute up to $3,000.
RMDs are taxed
While RMDs may not count as earned income, they’re still subject to income tax. This is because contributions to tax-deferred retirement plans like a traditional IRA or 401k were made with pre-tax income.
For example, if your RMD is $5,000 for the year, you cannot just deposit the entire amount directly into your Roth IRA. You’re required to first pay income tax on the $5,000 withdrawal first before using it as contributions for your Roth IRA. The amount you’ll be taxed on the RMD depends on your tax bracket, and tax rates at the time of withdrawal.
How to use your RMD to fund your Roth IRA
You have several options to use your RMD to fund your Roth IRA.
The regular method
The standard way of using your RMD to fund your Roth IRA is to take your RMD as a distribution, pay income taxes on the withdrawal, and then use the funds as contributions to your Roth IRA. Remember that you can only contribute if you have earned income from other sources, up to the contribution limit of $7,500, since RMDs do not count as earned income.
Avoid RMDs entirely by converting to a Roth IRA
You can also choose to avoid RMDs entirely by converting your traditional IRA or 401k to a Roth IRA. As mentioned earlier, a Roth IRA has no RMD rules so if you plan to reinvest all of your RMDs to a Roth IRA anyways, it might make more sense to do a Roth conversion instead.
Converting a traditional IRA or a 401k to a Roth IRA comes with taxes. Because IRA and 401k contributions are made with pre-tax income while Roth IRA contributions are made with after-tax income, you’ll owe ordinary income taxes on the amount you want to convert. Consult a financial planner or tax professional to decide whether a Roth conversion makes sense for you.
Understanding Roth IRAs
A Roth IRA is a type of individual retirement account that allows you to save for retirement while avoiding taxes on your investment earnings. Unlike traditional IRAs, you don’t get a tax deduction for contributions to a Roth IRA. However, you won’t have to pay any taxes on your withdrawals during retirement.
To contribute to a Roth IRA, you must have earned income, and your modified adjusted gross income (MAGI) must be below a certain threshold. For the tax year 2023, the income limits for contributing to a Roth IRA is $153,000 for single filers and $228,000 for married couples filing jointly. If your income exceeds the limits, you cannot contribute to a Roth IRA.
The maximum contribution limit for a Roth IRA in 2023 is $6,500 or $7,500 if you’re age 50 or older. This limit is the combined total amount you can contribute to all of your IRAs for the year. Since RMD payments only apply when you turn 73 years of age, you’ll be able to contribute up to $7,500 for 2023.
You can withdraw contributions only from your Roth IRA at any time, tax-free and penalty-free. However, to withdraw earnings, you must be at least 59½, and at least 5 years must have passed since your first Roth IRA contribution (the 5-year rule). If you withdraw earnings early, you may have to pay taxes and a 10% early distribution penalty.
As mentioned earlier, a Roth IRA has no RMDs. You’re not required to start taking distributions even if you turn 73 years of age and can keep the money compounding tax-free in your account as long as you’re alive.