Once you reach the age when the IRS requires withdrawals from tax-deferred retirement accounts, a certain amount of money must come out from those accounts each year, and taxes must be paid on those withdrawals.
While there are many options for what to do with the money, for investors who don’t need to use their required minimum distributions (RMDs) for living expenses, pulling them out in cash is often the default option.
“Cash is perfectly fine if you need or intend to use the money in the near term, or need to boost your emergency savings,” explains Matt Bullard, a regional vice president at Fidelity Investments. “But if you let your RMDs pile up in a cash account, over time, cash can become a bigger part of your portfolio. At that point, a more conservative overall portfolio than you intended means you’re potentially losing both purchasing power and the ability to grow your assets.”
Instead of defaulting to cash, Bullard suggests moving any RMD money you don't need for essential expenses into a taxable account and then putting it toward your long-term goals.
Whether you’re focused on optimizing your portfolio, managing risk, or supporting the next generation, here are 7 investment options for your RMD.
Review your portfolio
1. Consider an in-kind transfer
You can’t avoid paying taxes on RMDs, but you can potentially manage your holdings to minimize the impact of selling. For eligible positions, an in-kind transfer lets you move an investment from a tax-deferred account to a taxable account while keeping it intact, rather than selling it and repurchasing it. The fair market value of the shares at the time of transfer is reported for tax purposes and becomes their new cost basis in the taxable account.
2. Assess adding to underweight holdings
If your asset allocation has drifted from your desired allocation, you may find yourself overweight in certain asset classes. Recently, many retirees have found themselves heavy on stocks due to the long bull market. If that’s your situation, consider reinvesting your RMD dollars into underweight asset classes such as bonds or short-term fixed-income investments.
3. Explore tax-efficient investments
If you’re moving your RMD assets to a taxable account, keep in mind that unlike assets inside a traditional IRA, investments held in a taxable brokerage account can generate annual tax bills through interest, dividends, and capital gains distributions. But since you’ve already paid taxes on your RMD, you may understandably want to reduce future taxes on the same money.
In general, passive index funds and ETFs tend to be more tax efficient than actively managed funds, as do mutual funds that explicitly call out tax efficiency as an objective.
Or consider a managed account focused on helping reduce tax liability. Fidelity’s personalized portfolio accounts, for example, use tax-efficient investments, tax-loss harvesting, and other tax-smart investing techniques1 to help reduce the impact of investment gains.
Help manage future risks
4. Consider including inflation protection
If you don’t have an immediate use for your RMD money but think you might need it within the next several years, there are relatively low-risk options that still offer some growth potential, such as money market funds and Treasury Inflation-Protected Securities (TIPS).
The principal and interest payments on TIPS are designed to rise when inflation does, and they pose very little risk of default because they are backed by the full faith and credit of the US government.
5. Evaluate an income annuity
A lifetime income annuity is a contract with an insurance company that allows you to convert savings into a predictable stream of income for the rest of your life.
One option is a deferred income annuity2, which allows you to postpone payments until your late 70s or early 80s, when many retirees face increased healthcare costs. A provision of the SECURE 2.0 Act also allows excess income from a qualified annuity to help satisfy RMD obligations from other eligible retirement accounts.
Give the next generation a boost
6. Invest for a legacy
If you're confident you won't need your RMD assets for your own spending and you have a risk tolerance for more aggressive investments, you may want to invest them in a taxable account with your heirs in mind. While past results are no guarantee of future performance, historically, an aggressive portfolio of 85% stocks and 15% bonds generated annualized returns of 9.7% compared with 8.5% for a portfolio of 60% stocks and 40% bonds.3 “By investing aggressively, you may be able to leave a larger legacy,” says Bullard.
Investing for growth may also provide tax benefits for your heirs. When an asset is inherited rather than sold or gifted, the cost basis typically receives a step-up in basis to the fair market value of the property at the date of the individual's death. So if leaving an investment account to heirs is a priority, you may want to preserve investments with larger unrealized gains and spend from assets with lower capital gains when you need cash.
Keep in mind, however, that investing your RMD in a taxable account can potentially generate taxable events and affect the amount of taxes you pay, and investing aggressively can affect your overall asset allocation. If you want to invest for a legacy, a financial professional may be able to suggest options to potentially reduce your investment taxes, such as tax-loss harvesting or charitable gifting, and help you determine whether this strategy might be appropriate given your overall financial situation and tolerance for risk.
7. Explore funding education goals
If your children, grandchildren or other loved ones are college-age, you can choose to pay tuition directly. This can offer estate tax benefits, since you can pay an unlimited amount for someone's tuition directly to a qualifying educational institution without it counting as a taxable gift or eating into your lifetime gift tax exemption.
For younger children, you may want to consider investing funds in a 529 plan, a tax-advantaged account designed specifically for education savings. 529 plan earnings grow tax-free, and qualified withdrawals can be used to cover eligible education expenses from kindergarten through graduate school. You can also front-load up to 5 years of annual gifts into a 529 plan without triggering a taxable gift.
Next steps
Rather than viewing an RMD as money that simply needs to be withdrawn from your account, consider it an opportunity to reposition assets in a way that supports your broader financial priorities. “The IRS tells you to pay taxes on it, but they don’t tell you what to do with it after they take their cut,” says Bullard.
Not sure which option is best? Consider talking to a financial professional, who can help evaluate the choices and identify strategies that align with your long-term plan.