A new way to spend RMDs: Fund a 529 account

Use your RMDs on a gift your grandkids will never outgrow

A new way to spend RMDs: Fund a 529 account

Time to read: 2 min

In 2017, the oldest of the baby boomers became familiar with required minimum distributions (RMDs), the minimum amount you must withdraw from certain retirement accounts once you reach age 70½. Clearly, the IRS wants to ensure retirees have plenty of money for traveling and dining out in their silver years — oh, and the government wants the opportunity to tax some of the money that’s been sitting around in tax-deferred accounts.

But some retirees don’t need all of their RMD proceeds. If this describes you, and you have grandchildren, nieces, nephews or other special young ones in your life, why not invest in their future and direct your RMDs into their 529 account(s)?

There are several advantages to this practice, but first, know the facts about RMDs.

R is for ‘required’

Most retirement accounts are subject to the RMD rule, including:

  • Traditional, rollover and inherited IRAs
  • 401(k), 403(b) and 457(b) accounts
  • Keogh plans
  • Roth 401(k)s and inherited Roth IRAs

Account owners must begin taking RMDs from these accounts no later than April 1 of the year after they reach 70½. (Keep in mind that we are discussing tax regulations, so there are exceptions. Visit this IRS webpage on RMDs for more information and talk to your tax advisor.)

Using RMDs to fund a 529 account

If you’re in the enviable position of not needing your RMDs as income, there are three advantages to using your distributions to fund a 529 plan for a beloved child:

Tax-free earnings. When you receive your RMD, you will owe income taxes on the amount for the tax year in which you took the distributions. If you invest the RMD, you will likely owe a second round of taxes on any earnings down the road. If instead you contribute those distributions to, say, a grandchild’s 529 account, you’ll still pay income tax on the RMD, but the money invested in the 529 account will grow tax-deferred. And the entire amount is available tax-free if the money is used for eligible education expenses. (For more information on what constitutes an eligible expense, refer to my blog Three 529 withdrawal penalties to avoid.) Also, the amount you contribute is removed from your estate, even though you retain control over the funds as the account owner.

More federal financial aid. Aid calculations factor in the total resources of the prospective student, and to a lesser degree, the parents. The Expected Family Contribution (EFC) to a child’s college education calculated by the government takes into account 20% of a student’s assets, but just 5.64% of a parent’s assets and 0% of a grandparent’s assets. Funneling your RMDs directly to a student’s bank account will increase the amount they’re expected to pay for college, but establishing a 529 account in your own name with your grandchild as the beneficiary keeps your contributions on your side of the ledger. 

Flexibility. With a 529 account, you have options should circumstances change after you open the account. For example, you could establish a separate account for each grandchild and divide your annual RMDs among them. Then if one of your grandchildren gets a full scholarship or goes right into business after high school, you can change the beneficiary to another family member and retain the tax-deferred status of the account. It’s even possible to name yourself as beneficiary, if you’d like to go back to school during your retirement. (Here’s the IRS list of eligible schools. Golf Academy, anyone?)

Put your RMDs to work for the kids you love

If you’re fortunate enough not to need all or part of your RMDs, consider funding a 529 college savings account. I call it the gift of a lifetime: Kids can’t outgrow it, and it never goes out of style. And while taking RMDs may feel like a burden to you — just more taxable income! — that money could be the basis for a successful future for a beloved child in your life.

Your financial advisor can help you decide what makes the most sense for your total financial picture in retirement, including how to help your grandchildren and other loved ones save for college. Talk to your advisor and visit CollegeBound529.com, where you can access college savings tools and resources.

Source: IRS.gov

Important information

Blog header image: Yuganov Konstantin/Shutterstock.com

Thomas Rowley

Director, Retirement and Education Strategies

Thomas Rowley is director of retirement and education strategies and one of Invesco’s most frequently requested speakers. He provides analysis of the evolving retirement landscape and develops actionable strategies to help investors and financial advisors maximize their retirement-planning opportunities. Mr. Rowley regularly shares his insights online at invesco.com/us in addition to his speaking engagements.

Mr. Rowley’s insights reflect more than 20 years of experience in the investment industry. He translates his comprehensive knowledge of retirement planning into lively, clear explanations of the complexities of legislative, investing, tax and social issues.

Mr. Rowley shares his analyses of retirement-related issues through regular personal appearances, continuing education webinars and Web-based commentaries.

Mr. Rowley has been director of retirement business strategy since 2010. Prior to joining Invesco in 2010, he was in charge of individual retirement plan products and Retirement Marketing at Van Kampen.

Prior to joining Van Kampen in 1996, he was a 401(k) regional sales director with an investment firm. His experience also includes seven years in retirement plan operations and three years as head of a brokerage firm’s retirement help desk. He began his career in the Treasury bond futures pit at the Chicago Board of Trade.

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