Can I Invest my RMD into a Roth IRA?

Chances are that given you are reading this article, at some point you’ve invested some of your hard-earned money into a retirement vehicle, like an individual retirement account (IRA) or a work-sponsored plan, such as a 401(k), 403(b), pension plan, etc.

As such, you are probably aware those vehicles are considered qualified and allow you to defer paying taxes during your working years. But, you also know you’ll eventually owe the IRS taxes on money not previously taxed at some point.

Such distributions are known as required minimum distributions (RMDs) and they are governed by IRS rules. You must start taking them by a certain age.

On another front, you might have even taken advantage of a Roth IRA, which is another type of retirement plan – one you fund with after-tax dollars that grows with no taxes due later (on the principle or interest) if you do decide to take distributions from the account down the line. If you choose not to use the funds in the account you can pass them on tax-free to your beneficiaries.

With all of that as a backdrop, a pretty natural inclination would be combining your RMD with a Roth IRA contribution in order to avoid paying taxes on untaxed dollars. Who wouldn’t dig doing so?

In fact, that is a question often asked. Can I invest my RMD into a Roth IRA?

Introduction

You ever asked what you thought was a straightforward question, with an expectation that you’d receive a quick and easy answer in return, only to get an answer that seemed anything but?

You know what we’re talking about. The type of answer that seems ambivalent. Yes. Actually, no. Umm, it’s both. Well, it’s complicated. Depends on certain things…

Fact is there are lots of issues in finance that are that way. On the surface they seem straightforward, then the deeper you dig, less so. The answers often seemingly contradict themselves, depending on what year, where you live, how old you are, how much you’ve contributed, and on and on.

Required minimum distributions are certainly an issue that confuses many, leading them to seek out information and ask questions, only to get answers that seem to further confuse.

Roth IRAs can be much the same – they confound and confuse many people.

This article is going to tackle a frequently asked question involving RMDs and ROTH IRAs – namely, whether you can invest your RMD into a Roth IRA.

The quick answer is yes…and no. Okay, not so simple.

Yes, if you are wanting to take your RMD and invest proceeds as a contribution to a Roth IRA (under specific circumstances and up to a certain limit), but no if you are wanting to take advantage of a Roth IRA Conversion from a traditional IRA requiring an RMD.

Huh!

Before explaining the reason why, we should step back and take a refresher on RMDs and Roth IRAs to better understand what they are and why created. In doing so the answer will become clearer.

What’s an RMD

While RMDs are scary to many due to lack of knowledge, fact is when you pull the curtain back, it’s nothing more than an IRS rule. And the rule is all about the agency eventually getting back money owed (in the form of taxes) that they’ve been waiting to get their hands on for what’s likely a long time.

Let’s back up a bit to better understand why the government would feel it’s entitled to your money to begin with.

While it’s probably been some time since you first started doing so, you likely began preparing for retirement by making contributions into a qualified retirement account on your own, such as a traditional IRA or an employer-sponsored account like a 401(k).

Those dollars invested were contributed pre-tax, or before taxes were taken from your check. The government allowed you to do so as a benefit, encouraging you to diligently save for your eventual retirement.

In taking advantage of this government-sponsored provision, you gained a two-pronged benefit:

• The ability to pay less in taxes in a given tax year due to a reduction in your taxable income, leaving you with more of what your earned
• The ability to grow your retirement savings over time utilizing the benefit of compound interest

Overall, you’d have to admit that taking advantage of the government-provided benefit was a good thing and over time enabled you to accumulate a fair amount of savings for use in your retirement, or to pass on to loves ones or other beneficiaries upon your eventual passing.

Bill comes due                                                                                              

With almost all things in life there is a cost and sooner or later the bill comes due. In the case of an RMD, the IRS wants their pound of flesh and this required distribution is their mechanism for collecting.

It enables the agency to eventually capture taxes due by forcing individuals to take distributions from qualified retirement accounts (e.g., IRAs, 401(k)s and other vehicles) starting at age 72, or 73 if you reach age 72 after December 31, 2022. The RMD age further increases to 75 for those born 1960 and after.

Keep in mind that for most employer-sponsored retirement plan account owners, such as those in 401(k)s, they can delay taking their RMDs until the year in which they retire, unless they’re a 5-percent owner of the business sponsoring the plan, according to the IRS. But when they do retire, they must begin taking their RMDs.

*Note, according to the IRS, while you are required to take a distribution in the year you turn 72 (73 if you reach age 72 after December 31, 2022), your first RMD can be taken the year following your 72nd birthday by April 1st, but you will have to take your second RMD distribution by December 31st of that same year.   Example – you turned 72 in 2022, so you could delay your RMD until April 1, 2023 (based on your account balance as of 12/31/21), but you would have to take your second RMD by 12/31/23, based on your account balance as of 12/31/22.   One additional caveat to be aware of: given that the SECURE 2.0 Act raised the age that you must begin taking RMDs to age 73, if you reach age 72 in 2023, the required beginning date for your first RMD is actually delayed until April 1, 2025, for the 2024 tax year.

When you do take distribution you will owe taxes on the amount withdrawn, as this is treated as ordinary income in the year the RMD is taken, thus increasing your income for the year and increasing the amount of tax owed, accordingly.

Going forward, given that your life expectancy will decrease with each passing year, your RMD requirement will actually increase.

Failure to take distribution

If you do fail to comply, the amount not taken as a distribution has in the past been subject to a 50-percent excise tax. That’s in addition to the taxes due on any portion of the RMD that was distributed…ouch.

But the advent of the Secure 2.0 Act has effectively reduced the excise tax on the portion of the RMD not taken to 25-percent, and even 10-percent if the distribution is properly corrected within two years, according to the IRS.

Got all that? It actually gets much more nuanced, but that’s the basics.

Confusing? You bet!

What’s a Roth IRA

In simple terms, a Roth IRA is a type of retirement account for individuals. But unlike a traditional IRA, where you get a tax break in the year contributed, the contributions you make into the account are already taxed.

As such, the principal and interest earned over the years are tax and penalty free, allowing you to take distribution without owing any taxes. That is, as long as you are over age 59 1/2 and have held the account for at least five year.

Additional benefits of note are the fact there is no age limitation on contributions so you can continue to contribute as long as you have qualifying income, there’s no taxes due on a Roth IRA you pass on to heirs (they don’t pay taxes on distributions) and there are no RMDs, unlike a traditional IRA.

Keep in mind there are income limitations (based on your modified adjusted gross income or MAGI), as well as maximum yearly contributions when it comes to a Roth IRA.

• For the current 2023 tax year (which you will file in 2024), the income limitation is $153,000 for single filers and $228,000 for married joint filers
• For the current 2023 tax year (which you file in 2024), the maximum total annual contribution for all of your IRAs (traditional and Roth combined) is $6,500 up to age 50, and $7,500 if over age 50

If you are married, both people can have and contribute to their own traditional and Roth IRAs, subject to the aforementioned income limitation and yearly maximums.

In the event you or your spouse doesn’t work but you do file jointly, according to the IRS, you can contribute to a spousal IRA or Roth IRA, but the combined contribution can’t exceed either your joint taxable income or double the annual IRA limit, whichever is less.

Roth Conversion

This is an available strategy of repositioning assets from qualified plans (IRAs and employer-sponsored plans) into a Roth IRA. When doing so, the amount converted is treated as ordinary income that must be paid, which can add up to a substantial tax bill owed in the year of the conversion.

The benefits of a Roth Conversion is the fact the principal and interest within the converted Roth IRA are now tax-free going forward, there is no RMD associated with the account (unlike a traditional IRA) and you can pass on assets tax-free to your beneficiaries.

Once again, we have to ask – got all that? And, as with RMDs, there’s actually more,  but that’s the basics.

The answer…explained

This is where it gets a bit wonky.

What you can do – take a RMD in a year required, which will be considered a taxable event. The proceeds from the distribution will be treated as income, increasing your overall ordinary income for that year.

You’ll pay taxes based on your tax bracket, which may get bumped up given the increased income. The net result is you’ll likely experience an increased tax burden. And you may be hit in other ways, such as increased Medicare premiums.

The key consideration is that you will have paid taxes due on the amount you took as a required distribution. The IRS will have finally received their pound of flesh.

Regarding the distribution proceeds, while you can’t reinvest them back into most qualified retirement accounts, such as an IRA or 401(k), you can do so into a taxable account, such as those offered by mutual funds and brokerages. You can even invest them into a tax-deferred 529 education account.

More importantly, and direct to the point of our question, you may be able to invest them into a Roth IRA, as long as you have earned income that is equal to or greater than the contribution amount. Additionally, the aforementioned restrictions in terms of maximum income and annual contribution limits will apply.

What you can’t do – you can’t convert a qualified account (such as a traditional IRA) to a Roth IRA and use the conversion to satisfy your RMD for that year. You must first satisfy your RMD requirement, and then in the next year you can perform a Roth Conversion. At that point you gain the benefits of a Roth IRA for the assets held in that account.

Conclusion

As stated previously, RMDs tend to intimidate many people. We covered the basics here, but there are exceptions and many consideration and nuances that can make it easy to get tripped up.

The same holds true for Roth IRAs, ranging from who can contribute, how much, whether to convert, and more.

Combining the two can get downright tough.

• Can I contribute my RMD to a Roth IRA? The answer might be yes, but with caveats.
• Can I convert the IRA I own to a Roth and use that transaction (and resulting taxes) to satisfy my RMD for the year? No, not in this year, but the IRA can be converted in the following year. And when you do so, the Roth IRA won’t require RMDs.

Yikes…it’s no wonder this gets confusing to the average person.

As should be evident at this point, for most people dealing with RMDs and Roth IRAs, they’d be best served using the services of a qualified retirement planner that can help them avoid the myriad issues and pitfalls that could end up costing them dearly.

Oak Harvest can work with you to address these complicated issues, and more, that you’re likely to run into as you move into retirement and your advanced years.

We’ll build a holistic, comprehensive retirement plan addressing these and all relevant issues, utilizing strategies that cover taxes, income, spending, healthcare, legacy, and more, customized to your family’s specific needs. A plan created with the goal of ensuring you have the best opportunity of living out the retirement you and your spouse envision.

If you are ready to take the next step and talk to a team of retirement planners who can advise on all your retirement needs, and who will put your interests first, Schedule a call today!