Will reinvesting my RMD trigger double taxation?

If I don’t spend all of my required minimum distribution (RMD) money each year, can I put some of it back into my stocks? If so, will I be taxed on the refund? Would this be double taxation? If I am only taxed on the additional interest this money earns when I reinvest it, how would that interest be calculated and tracked? Also, would this additional income be better spent on other investments such as real estate given that you can write off the expenses?

-Karen

You can use the RMD money any way you want, including reinvesting it in stocks. Then it would act like any other non-retirement investments you have. The RMD itself would no longer be taxed, so there would be no double taxation. But if the new investments generated any income, it would be taxed.

Each year, you receive a 1099 for any interest or dividends earned on securities or information on any securities sold. If you choose to invest directly in rental property, you will be taxed on any rental income that exceeds your expenses. Other real estate investment options would be taxed more like ordinary securities than outright ownership of rental properties.

Consulting with a financial advisor can help determine which investments would work best with your existing investments and retirement accounts. Contact a fiduciary advisor.

When You Don’t Need Your RMD

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RMDs must be withdrawn from retirement accounts before taxes, regardless of whether you need or want to take the money out. Since this money has not yet been taxed, the IRS wants to make sure that the withdrawals are taken and that the money is finally taxed.

But what you do with your RMD money is entirely up to you. Among the many options for this money you could:

• Use it to pay for regular expenses

• Invest it

• Contribute to a Roth IRA (if you have enough earned income)

• Donate it directly to charity as a qualified charitable distribution (QCD) and avoid RMD taxes (assuming the RMD is from an IRA)

• Give it to a loved one

• Save it for a rainy day

There are no restrictions on what you do with your RMD after you take it, as long as you take the required amount. (But if you need help planning and managing your RMDs, contact a financial advisor and see how they can help.)

Many Investment Options

Investing in your RMD can be a great way to keep your money working for you. Before deciding how to invest it, review your entire portfolio to determine the best way to add value to your current holdings. You’ll also want to consider how soon you might want to use that money—your time horizon—as this can also affect your investment choices.

The story continues

Stocks offer the opportunity for growth, especially over the long term. Many corporations regularly pay dividends to their shareholders, which would increase current income streams or could be reinvested. You can invest in stocks directly or through mutual funds or exchange-traded funds (ETFs). (A financial advisor can help you evaluate different investments and choose the best ones for your situation.)

Real estate can also be a profitable investment and can be made in a number of ways. In addition to buying properties to rent or flip, you can also invest in real estate investment trusts (REITS), real estate funds, or crowdfunded real estate.

• REITs are similar to mutual funds and ETFs, but they own dozens or hundreds of rental properties or mortgages, providing a diverse real estate portfolio with each share.

• Real estate mutual funds, or ETFs, hold a variety of REITs and possibly other securities focused on real estate (such as stocks in the construction industry, for example).

• Crowdfunding gathers money from many investors to finance real estate projects or buy private real estate investments that would otherwise be inaccessible to most investors.

REITs, real estate funds and crowdfunding offer the opportunity to invest in real estate with minimal cash outlays, which can be a more flexible financial choice.

How investments are taxed

Investments are only taxed when you make money from them. The form these gains take depends on the type of investment. For example, stocks can provide dividend income, bonds provide interest income, and rental properties generate rental income. In addition to those current gains, the investments will also be taxed when you sell them for a profit.

When you buy any investment, the total amount you pay for that investment counts as your basis. Basis is used to calculate any gain or loss when the investment is eventually sold. That means you won’t pay tax on the amount invested, just the extra money you get when you sell it.

For example, if you bought some stock for $10,000 and later sold it for $12,000, you would only pay tax on the $2,000 gain. (If you need help planning the fees you’ll pay on your investments, consider talking to a financial advisor.)

Tax benefits of direct real estate investments

Investing in rental properties offers a unique opportunity to generate positive cash flow and tax losses. This is due to the wide variety of expense write-offs that rental properties offer. Owners can deduct expenses directly related to the property, along with the costs of running that business.

Common property tax deductions include:

• Mortgage interest

• Property insurance

• Property taxes

• Administration fees

• Repairs and maintenance

• Advertising for tenants

• Legal fees

• Accounting fees

Along with these cash-intensive expenses, rental properties are also subject to depreciation. This allows you to deduct a portion of the cost of the property each year, increasing your losses. These expenses offset the rents that are collected and reduce the taxable income that the investment generates. (If you want to invest in rental properties, a financial advisor can help you plan this.)

Conclusion: Reinvesting your RMD can provide the potential for growth and additional income in retirement. Evaluating your portfolio, especially with input from a trusted financial advisor, can help you figure out what types of investments will be best for your situation.

Tips for finding a financial advisor

• If you need help finding and choosing a financial advisor, start by assessing your needs and goals. Maybe you’re looking for help selecting investments or managing restricted stock units (RSUs) that your company has awarded. Or maybe you are looking for complete financial planning services. Assessing your needs and goals can help you determine what services the advisor you hire will need to provide.

• Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool matches you with up to three verified financial advisors serving your area, and you can have a free introductory call with your matched advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help reach your financial goals, get started now.

• Keep an emergency fund handy in case you face unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations, such as the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But a high interest account allows you to earn compound interest. Compare savings accounts from these banks.

• Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with prospects and provides marketing automation solutions so you can spend more time converting. Learn more about SmartAsset AMP.

Michele Cagan, CPA, is SmartAsset’s financial planning columnist and answers readers’ questions about personal finance and tax topics. Have a question you’d like answered? Email [email protected] and you the question may be answered in a future column. Questions may be edited for length and clarity.

Please note that Michele is not a participant in the SmartAsset AMP platform, nor is she an employee of SmartAsset. She was compensated for this article.

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