The retirement landscape for many Americans was altered significantly in December 2019 when the SECURE Act became law. Several facets of the legislation were intended to increase access to tax-advantaged accounts for many Americans. Another provision, though, aims to prevent older retirees from outliving their retirement assets.
The Act changed the age for required minimum distributions (RMDs) from qualified retirement accounts, from 70½ to 72. This was the first change in RMD regulations since they were first implemented as part of a series of tax reforms in the late 1980s.
Which Accounts Are Impacted?
The new RMD rules apply to virtually all defined contribution retirement accounts including traditional IRAs, (SEP) IRAs, and (SIMPLE) IRAs. Also included are 401(k)s, nonprofit 403(b) plans, and government 457 plans.
Not included are Roth IRAs, which don’t require RMDs since these accounts are funded by after-tax contributions. An exception would be a Roth IRA that is inherited; these accounts are subject to RMDs.
RMD Calculations and the IRS Penalty
Generally speaking, your RMD is based on the market value of your retirement accounts divided by your life expectancy as determined by the IRS.
For some clarity on the process involved when you actually reach the age when you must begin taking your required withdrawals, see the IRS guidance here.
While you may take a distribution greater than the required minimum, a failure to withdraw that RMD will be a painful process indeed. In what has to be one of the most draconian penalties in the IRS code, you will pay a 50% penalty on the amount you should have taken. Additionally, you will still need to take the full RMD amount eventually and pay any income taxes due when that distribution occurs. Ouch.
How the Change in Age Affects You
In reality, most retirees cannot afford to wait until the age that RMDs commence. In 2021, the IRS estimates that only 20.5% of retirees will withdraw the minimum. https://www.federalregister.gov/documents/2019/11/08/20
For those that can afford to extend the withdrawal time frame past average retirement age though, there are a few matters to consider.
- Near-Term Income Tax Consequences: The most straight forward benefit for taxpayers regarding these rule changes is the continued deferral of income taxes on their retirement accounts that are tax-advantaged. Also, if you are already retired, and you don’t need income from these accounts before age 72, you may be able to keep your marginal tax rate as low as possible. If you can draw on a taxable investment portfolio (or even social security after full retirement) rather than accessing your IRA account, then you may be able to prevent from moving into the higher tax bracket when an RMD triggers a tax event.
- Longer-Term Income Tax Consequences: Another approach for those with substantial balances in a traditional IRA account would be to take steps to reduce the size of their tax-deferred account. One way to accomplish this is by converting part of your traditional IRA to a Roth IRA. Previously, RMDs could not be converted to a Roth as a normal distribution. But because distributions for this year are not treated as RMDs, Roth conversions can take place utilizing tax rates for 2020. If you are so inclined, another way to reduce your tax bite once you have reached age 70½ is through a qualified charitable distribution from an IRA account. See: https://www.irs.gov/publications/p590b
- Still Employed After Age 70: If you are still on the job and are contributing to a 401(k) account through your employer, you can defer your RMDs until April 1st of the year after you stop working. You cannot own more than 5% of the company you work for. This rule does not apply to IRAs.
Required Minimum Distributions Conclusion
If you have a retirement account that could be subject to RMDs, now is a great time to confer with your financial advisor or tax professional to ensure you are making the most of the changes generated by the SECURE Act. Make sure you understand all the implications of the Act and how they impact your personal situation.
Bryan Blackburn, CFP® serves as Financial Planner and Wealth Advisor at Carnegie Investment Counsel. As a CERTIFIED FINANCIAL PLANNER™, he manages relationships for select clients. Bryan provides holistic financial planning advice; including retirement planning, cash flow analysis, tax planning, education funding, and estate planning and investment analysis.
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