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Smart IRA withdrawal strategies

Knowing your income needs and options is key for minimum required distributions.

Smart IRA withdrawal strategies

Every year, if you’re age 70½ or older, you generally need to withdraw a certain amount of money from your IRA, 401(k) plan, or other workplace savings plan. The withdrawals are required by the Internal Revenue Service.

Distributions from traditional IRAs (non Roth), are usually taxed as ordinary income, although part of these distributions may be nontaxable if you've made after-tax contributions to these accounts. While you‘re required to take these minimum required distributions—known as MRDs or RMDs—you have some flexibility on timing and what to do with the money. For instance, you may not need it for essential living expenses, so you may want to earmark it for heirs, grandchildren, or a charity. Note: Withdrawals may be nontaxable if they are made directly to a qualified charitable organization.

To come up with an MRD strategy that works for you, it helps to first understand the basics and then answer four key questions. Your answers will help you choose a strategy that makes sense for your financial situation.

MRD basics

Generally, your MRD is determined by dividing the prior year's year-end balance (the adjusted market value of your IRA as of December 31 of the previous year) by a life expectancy factor from an IRS table, typically the Uniform Lifetime Table.  

The full amount of your MRD must be withdrawn from your IRA no later than December 31 each year. There's a powerful incentive to do it by that date: If you don't, you'll be hit with a 50% penalty on the amount you were supposed to withdraw but didn't. For example, say your MRD this year is $25,000, but you withdraw only $10,000. You failed to take out $15,000—so the IRS would fine you half that amount, or $7,500.

Those who are turning age 70½ can take advantage of a one-time delay in taking their MRD. They have the option of taking their first MRD no later than April 1 of the year following the year they turn 70½. But, should you choose to delay a distribution, be aware that you will have to take two MRDs in one calendar year—one that covers the previous year in which you turned 70½ and another for the current year. Both of these distributions may be taxable within the year they are taken. Roth IRAs are not subject to these MRD rules. They don't require minimum distributions during the lifetime of the original owner.

You can leave assets in a Roth IRA as long as you live, with no penalty.1 (Note: Designated Roth accounts in 401(k) plans do require minimum distributions. You can also delay taking MRDs from a 401(k) or other current employer's workplace savings plan if you continue to work beyond age 70½, provided you don't own more than 5% of the business you work for. In that case, you have until April 1 of the calendar year after the year in which you retire to begin taking MRDs.

MRDs and your retirement income plan

It’s important to determine how MRDs fit into your overall retirement income plan, especially if you need the cash flow to cover expenses.

Building a sound retirement income plan—one that can match your income sources with your expenses—is a critical component in achieving overall financial success during retirement. And, if you don't absolutely need the money, you can make some decisions about the best way to use the funds. 

"Only one out of four preretirees has a written, personalized retirement income plan, much less a plan for managing MRDs, according to the Life Insurance Marketing and Research Association,"2 says Ken Hevert, Fidelity vice president of retirement products. "Taking the appropriate steps can help you make the best use of your savings and distributions—and help avoid costly mistakes." 

You may not need your full distribution to meet essential expenses. In that case, you have some flexibility with the timing of your withdrawals and for reinvesting the money you pull from the account. And, if the distribution is taken in kind (shares distributed to a nonretirement account rather than cash) no reinvestment may be necessary. "You may have more control over these assets than you think," Hevert notes.

Four key questions to ask

1. Do you need the money to cover living expenses?

“If you’re planning to spend your MRDs, one big consideration is managing your cash flow,” explains Hevert. You may want to consider arranging to have payments sent directly to a cash management account that provides flexible access to the money with features such as checkwriting, ATM use, and online bill payment.

It’s important, however, to be aware of fees that may be associated with cash management accounts as well. The less money siphoned off in ATM or online banking fees, the more you’ll have to spend. Last, if you’re concerned about the security of your funds in a cash management account, consider using one that provides FDIC insurance on your deposits.

Arranging to have the funds automatically distributed to a cash management or taxable brokerage account also helps to ensure that your MRD requirement will be met by the deadline of December 31 each year, avoiding an IRS penalty on funds withdrawn after the deadline. When planning your budget, bear in mind that you’ll owe income tax on any MRDs and other withdrawals from traditional retirement accounts. You can have taxes automatically withheld from your MRDs. If you choose not to do this, make sure you set money aside for tax time.

There are a few different “systematic” withdrawal methods that you may want to consider to help you satisfy your MRD requirement:
 

  • Recalculation method (IRS rules): This is the required method of calculating your MRD according to IRS rules. It requires annual distributions2 from your account based on your life expectancy, and is recalculated each year.
  • Annuitization method: This method requires the purchase of an annuity that can help turn your IRA assets into a stream of income payments, guaranteed for life.3 This method guarantees a set level of retirement income, regardless of your life expectancy,4 and helps reduce your risk of a budget shortfall. In addition, it provides more income beyond life expectancy than other options.4 This method does not guarantee that you will comply with the IRS MRD rules. There are two options to consider when deciding if the purchase of an annuity may be right for you and your retirement income plan:
1. Fixed payment option: where lifetime payments remain level and additional principal withdrawals aren’t allowed after purchase.
2. Variable payment option: where lifetime payments vary over time, based on performance of the underlying investments you choose. In some cases additional withdrawals after purchase may be allowed.5

2. Do you plan to reinvest the money?
If so, you may want to consider having any MRDs routed to one of your nonretirement accounts, where you can invest the money according to your goals, time horizon, risk tolerance, and financial circumstances.

Say you want to use the assets to help pay for college costs for a family member or friend. In this case, you can arrange for your MRDs to be deposited directly into a 529 college savings plan, although this will not avoid the tax due on the MRD. A 529 college saving plan helps to shield any future income and realized capital gains from annual taxes, and withdrawals are tax free as long as they're used for qualified higher-education expenses. 

If you invest your MRD in a taxable account, you may want to arrange your investment strategy so the account holds tax-efficient securities. This approach may help minimize investment returns adding to your tax bill.

  • Municipal bonds and municipal bond funds pay income that is free from federal income tax and, in some cases, from state and local taxes (note that income from some municipal bonds and funds is subject to the federal alternative minimum tax).
  • Stocks you intend to hold longer than a year that may pay qualified dividends. Sales of appreciated stocks held more than a year are lower taxed at long-term capital gains rates. Just be sure any dividends the stock pays are qualified. Qualified dividends are taxed at the same low rates as long-term capital gains, but nonqualified ordinary dividends, such as those paid by many real estate investment trusts (REITs), are taxed at ordinary income rates.
  • Equity exchange-traded funds (ETFs). The unique structure of many ETFs investing in equities may help investors by allowing them to delay realizing taxable capital gains.
  • Tax-managed and other tax-efficient equity mutual funds, such as index funds, trade infrequently and may use other techniques that seek to minimize a shareholder's tax liability.

Meanwhile, you may want to consider investing the existing assets in your IRA or other retirement plan in investments that are not tax efficient, such as taxable bond funds, REITs, or short-term stock holdings. Whether you invest the money for your own purposes or for someone else's education, be sure to allocate the money according to investing fundamentals.

"Know what the purpose of the money is, how long until you'll need it, and how much risk you're willing to take—and invest accordingly," says Hevert.

3. Do you plan to pass assets on to your heirs?
If so, you may want to consider converting IRA assets to a Roth IRA. Investors of all income levels are permitted to convert traditional IRAs and 401(k) plans from previous employers to Roth IRAs.

When drawing up a will, you may want to consider your current tax rate applied to converted IRA assets versus the tax rate your heirs would pay on inherited assets. If your heirs will be in a higher tax bracket than your own then it may make sense to convert.

The Roth IRA's absence of minimum required distributions during the lifetime of the original owner means you can leave the assets in place for as long as you live, with the potential to generate tax-sheltered growth for future generations. Your heirs will have to withdraw a minimum amount each year after they inherit the account, but they generally won't be taxed on those distributions, which potentially increases the value of your bequest. You will have to take out any MRD amount first before you convert your remaining assets in your IRA to a Roth IRA. Note: While Roth IRAs are generally not subject to income tax, they are still subject to estate tax, so it is important to plan accordingly.

When you convert an IRA, you'll have to compute the income tax on the portion of the account assets converted. Ordinarily, the entire amount converted becomes taxable income, but if you've made nondeductible contributions to any IRA, the percentage of your total IRA assets composed of investment earnings and tax-deductible contributions is determined and applied to the converted assets. When the employer plan assets are converted, the taxable portion of the conversion is determined separately from all IRA assets and from any other employer plans.

There are a number of factors to consider before converting to a Roth IRA. If you have a long investing time frame, you may have enough time to benefit and recoup the tax hit if you decide to pay the taxes with money from your account. However, if you are close to retirement, a conversion generally may make sense if you can pay the tax out of other savings, rather than tapping into the assets in the account you want to convert.

Another option to consider when your goal is to pass assets on to your heirs is a "dividends and interest only" strategy for spending down assets in retirement. In this case, you would invest in interest-paying bonds and dividend-paying stocks with your IRA. In some cases, the interest and dividends generated within the account may be enough to cover your MRDs, and allow you to preserve most, if not all, of the principal in your account. This method does not guarantee that you will comply with the IRS MRD rules.

4. Do you want to make charitable donations now?
If so, a strategy involving a Roth IRA conversion and charitable contributions may advance your philanthropic goals while potentially enhancing your retirement account's flexibility and tax sensitivity.

The strategy involves performing a Roth IRA conversion, then making a charitable contribution out of a taxable account in the same amount as the conversion. In general, the goal is for your donation to help reduce your taxable income by the same amount that the conversion increases it, leaving you with little or no tax impact.

For example, say you plan to convert a traditional IRA to a Roth IRA and $100,000 of the assets in the account will be taxed. Making a deductible charitable donation from a taxable account worth $100,000 would offset the converted assets, leaving you with no additional liability.

The upshot? Your account would be converted to a Roth IRA—eliminating future MRDs and providing tax-free potential growth1—at little or no cost and you'd advance your philanthropic objectives. Note: There are IRS limits to deductible charitable donations. Generally the limit is 50% of AGI if cash is used and 30% if appreciated securities are used.

"This move is driven by the desire to convert to a Roth IRA," cautions Hevert. "If you don't have a need for a conversion, you may be better off not converting and simply making a charitable donation."

Generally, anyone who is over age 75 and has large charitable intentions should skip a Roth conversion, unless he or she is in extremely good health. Typically, the most tax-efficient asset to leave to charity at death is a traditional IRA because the charity does not pay income tax, and the charitable bequest is excluded from an investor's taxable estate. While there may be exceptions to this general rule, the majority of older taxpayers with substantial charitable intentions will fall under this rule.

Whichever scenario applies to you, MRDs are likely to play an important role in your finances in retirement. Building a thoughtful retirement income plan can help you use MRDs in the most effective ways and help you reach your important financial goals. At the very least, it's important to spend some time understanding MRDs and your options to help avoid a costly mistake.

Next steps

  • You can enroll in automatic withdrawals to manage your MRDs from your Fidelity retirement accounts each year. This service will calculate your MRD each year and distribute that amount based on your instructions. You can set up automatic withdrawals (login required) for MRDs for your Fidelity IRAs online.
  • You can also view your MRD amount and track how much you have taken during the year by looking on the Fidelity.com "Account History" page for each retirement account. Look on the right-hand side of the screen for each account. The MRD Tracker (login required) shows the estimated MRD amount and how it was calculated, the year-to-date distributions taken from that account, and whether the account is enrolled in an automatic withdrawal plan.
  • Learn more about MRDs, including  frequently asked questions.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus containing this information. Read it carefully.


1. A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, become disabled, make a qualified first-time home purchase, or die.

2. Source: Life Insurance Market and Research Association, Retirement Income Trade-offs, Implications for Product Development, 2009.

3. Guarantees are subject to the claims-paying ability of the issuing insurance company. In return for a variable lifetime income benefit, the issuing company does assess an insurance charge.

4. In the event of your premature death, the issuing insurance company may provide your spouse or beneficiary with either a lump-sum payment or continued payments over the remaining guarantee period.

5. Taxable amounts withdrawn prior to age 59½ may be subject to a 10% IRS penalty in addition to ordinary income tax.

ETFs may trade at a discount to their NAV and are subject to the market fluctuations of their underlying investments.

Municipal money market funds normally seek to earn income and pay dividends that are expected to be exempt from federal income tax. If a fund investor is a resident in the state of issuance of the bonds held by the fund, interest dividends may also be exempt from state and local income taxes. Such interest dividends may be subject to federal and/or state alternative minimum taxes. Certain funds normally seek to invest only in municipal securities generating income exempt from both federal income taxes and the federal alternative minimum tax. However, outcomes cannot be guaranteed, and the funds may sometimes generate income subject to these taxes. Generally, tax-exempt municipal securities are not appropriate holdings for tax-advantaged accounts such as IRAs and 401(k)s. Fund shareholders may also receive taxable distributions attributable to a fund's sale of municipal bonds.

Changes in real estate values or economic conditions can have a positive or negative effect on issuers in the real estate industry, which may affect the fund.

The tax and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

The MRD Calculator is intended to serve as an informational tool only, and should not be construed as legal, investment, or tax advice. Please consult a tax advisor or an investment professional about your unique circumstances. Please verify carefully the information that you enter. The results from the MRD Calculator are based on the information you provide throughout the tool, and are only as valid as the information provided by you. Therefore, Fidelity Investments cannot guarantee the accuracy of the results.

Hypothetical results from the Roth Conversion Evaluator should be interpreted in light of its assumptions, which can be found within the calculator. To the extent that these assumptions do not apply to your situation, the results may be less appropriate for you.

The Roth Conversion Evaluator is intended to serve as an educational tool and should not be construed as tax or investment advice. Your circumstances are unique; therefore, if you believe that you need personalized tax advice, you should consult a tax advisor. Because your circumstances will probably change over time, it is a good idea to review your financial strategy periodically to be sure it continues to fit your situation. All examples are hypothetical and are intended for illustrative purposes only.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

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