How Does the New RMD Rule Affect Retirees?
There’s good news for your retirement plan! Starting this year, the age at which you must start taking required minimum distributions (RMDs) from your tax-deferred retirement accounts has increased from 72 to 73 years old. In 2033, it will increase again to age 75.
This new rule was passed into law by Congress at the end of 2022 as part of the SECURE Act 2.0. The Act implements several changes to retirement planning for individuals and employers alike, including increased limits on retirement account catch-up contributions for older individuals, as well as minimizing penalties for early withdrawals for people impacted by natural disasters and other emergency expenses.
Congress last raised the RMD in 2019, when SECURE Act 1.0 raised the age to 72, after holding steady at 70½ for more than 40 years.
The RMD rule change means that the savings in your 401(k)s and traditional IRAs can grow longer — giving you more opportunity to take advantage of compounding returns — before you must begin drawing down your account.
Here is a brief introduction on what to expect from RMD policy changes, and how they may impact your retirement plan strategy.
What is an RMD?
Retirement savings in 401(k)s and traditional IRAs grow tax-deferred and are taxed upon withdrawal. The government wants to safeguard against individuals using their retirement plans to avoid taxes, so they require you to withdraw money from your accounts after you reach age 73.
RMDs are determined each year by calculating the value of your retirement account and current life expectancy, and they will vary from person to person. The RMD amount will also vary each year, depending on the size of your account holdings and the most recent life expectancy factor published in the IRS’ Uniform Lifetime Table on December 31st of each year.
Your RMD is the minimum amount you must withdraw each year, but you are able to withdraw more than that if needed. And though your annual RMD can be withdrawn in a lump sum, you can also opt to space out disbursements each month or over quarterly payments.
While the RMD rule change provides an opportunity for you to grow your savings, one potential downside is that larger retirement accounts will lead to higher RMDs and result in greater tax liability. Your financial advisor can help you explore strategies to limit taxes, such as rolling over a traditional IRA to a Roth IRA with tax-free withdrawals.
Why are RMD policies changing?
Average life expectancy in the U.S. is currently 76 years, according to the Centers for Disease Control and Prevention.1 This is an increase since the 1970s when RMDs were first implemented and life expectancy was 72 years.
Because people are living longer, and in some cases retiring later, a delayed RMD can mean the potential to make your retirement funds last longer.
What happens if I don’t take my RMD?
Failure to make your required minimum distribution results in an excise tax on those funds. Until last year, the tax penalty was 50% of that year’s RMD. Another provision of the SECURE Act 2.0 reduces that penalty significantly to 25% — and while the penalty reduction is good news for retirees, it’s still a steep cost you’ll want to avoid.
Regardless of when you’re planning to retire, calculating your estimated RMD is a key component of your retirement financial planning strategy. Your financial advisor can help you create a forecast so you will know how much income to expect in your retirement, how to plan for tax efficiency, and how to avoid unnecessary penalties.
1 Centers for Disease Control and Prevention, “Life Expectancy in the U.S. Dropped for the Second Year in a Row in 2021,” 2022.
Sources:
https://www.schwab.com/learn/story/congress-passes-major-boost-to-retirement-savings
https://www.kiplinger.com/retirement/new-rmd-rules
https://www.kiplinger.com/retirement/bipartisan-retirement-savings-package-in-massive-budget-bill
https://www.cdc.gov/nchs/pressroom/nchs_press_releases/2022/20220831.htm
https://www.kiplinger.com/retirement/downside-of-delaying-rmds
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty.
Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
RMD's are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.
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