If you don't need your required minimum distributions (RMD) from your traditional IRA for living expenses, can it be reinvested in a Roth IRA? Yes, you can—assuming you are eligible for a Roth based on your income.
This is because the money to fund your IRA can come from any pool of cash that you have available. However, there are contribution limits and income requirements.
- If you don't need all the money from your IRA's required minimum distributions, you may be able to invest it in a Roth IRA.
- You must have enough earned compensation for the year to cover the Roth contribution.
- You must be eligible for a Roth IRA in the first place, based on the income limits set by the Internal Revenue Service.
How Required Minimum Distributions Work
With a traditional IRA, contributions or deposits are made with pretax dollars, meaning you get a tax deduction on that contribution in the tax year that you made it. In return, you pay income tax on the distribution amounts when the money is withdrawn in retirement. At age 72, you must begin taking annual required minimum distributions (RMD), which is calculated based on the total amount saved in all of your traditional IRAs.
Conversely, Roth IRA contributions are with after-tax dollars, meaning you don't get a tax deduction in the year of the contribution. However, you get to withdraw the money tax-free in retirement. Also, there are no RMDs with Roths.
However, there was an exception for RMDs in 2020. RMDs were waived as a result of former President Trump signing the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law on March 27, 2020. The suspension of required minimum distributions from IRA accounts was designed to help the IRA savings of retirees to recover from any corrections or downturns in the stock market in 2020.
But if you are 72 in 2021, you must resume RMDs and continue for every year after.
Investing an RMD into a Roth IRA
The Internal Revenue Service (IRS) requires that you have enough taxable compensation to cover your Roth IRA contribution for the year, but the actual source of your contribution need not be directly from your paycheck.
Also, the IRS has an annual contribution limit of $7,000 for those age 50 and older in 2020 and 2021. The contribution limit includes the total amount of combined annual contributions for both traditional IRAs and Roth IRAs. In other words, if your RMD was less than $7,000, all of the money could be deposited into a Roth IRA. However, if you contributed $4,000 to an IRA in the same year, only $3,000 from your RMD could be placed into a Roth IRA.
There are various Roth IRA contribution rules. The contribution limitations are based on your income and tax-filing status such as single, married filing jointly, widow, or married filing separately.
Remember, Roths don't have an initial tax deduction for the initial contributions, but they allow investors to withdraw the money tax-free and have no RMDs.
Avoiding Required Minimum Distributions
There is the option of converting your traditional IRA into a Roth IRA—called a Roth IRA conversion. Since Roths don't have required minimum distributions, once the funds are in the Roth IRA, you will no longer be required to take RMDs.
However, the Roth IRA conversion is a taxable event. Since you received a tax deduction on the contributions into your traditional IRA, you need to pay those deferred taxes on the converted funds.
You should check with a tax professional to determine whether a conversion would be a good financial move for you, as there are other factors to consider besides the RMD issue. For example, converting money from a traditional IRA to a Roth could push you into a higher tax bracket, meaning your marginal tax rate could be higher for that year.
If you do decide to convert to a Roth IRA, remember to take an RMD from the traditional IRA one last time for the conversion year. That's necessary because the traditional IRA still existed during that year.