Required Minimum Distributions (RMDs) are, as their name suggests, required. If you don’t withdraw the required minimum, then the IRS charges you a 50% penalty on the money you should have withdrawn.

However, some people make the opposite mistake and don’t stop at distributing just the required minimum. They think, “Well, while I’m at it, I may as well pull out a little bit more so we can fully cover the kitchen remodel…” and, just like that, distribute more than they need. It’s the “Would you like to round your bill up to an even $40 and donate to our charity” principle that drives such mindless spending.

The fallacy that causes this is called anchoring. We anchor our thinking on the number of our RMD, say $9,543.12, and think $10,000 or even $12,000 isn’t too much more. However, the consequences of withdrawing money from your IRA mean that the amount you really want to withdraw is $0. When you use that as your anchor, suddenly $12,00 and even $9,543.12 seem excessively large.

The extra $3,000 over and above your RMD is taxed as ordinary income like the rest of it, which would cost you $750 at the 25% bracket. If you’d just distributed the funds from your brokerage account to pay for your kitchen remodel, you would have gotten to save that $750 instead of paying it to the IRS in taxes. If you do save the extra money you withdraw, it will take up residence in a taxable account where the gains will now be taxed at capital gains rates whereas if that money had remained in your IRA, its growth would not have been taxable as long as it stayed in that account.

Anchoring off of a monthly distribution only compounds the error. Say you need to distribute $5,421.10 each month to meet your RMD of $65,053.20, but you decide to round up to an even $6,000. “It’s only $500 or so more!” you say. Of course, it’s an extra $580 per month, which over the course of the year comes to an extra $6,946.80 you’ve distributed. At the 25% tax bracket, that’s $1,736.70 you’ve donated to the IRS this year.

There are reasons to distribute more than the minimum, but if you have savings or an income source other than your IRA, chances are those reasons don’t apply to you. If you can tolerate the extra tax on your return this year, you’d benefit more from doing a Roth conversion with the extra IRA money than over-distributing from your IRA.

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