RMD delay: Good news for retirement savers—maybe
Last week the House of Representatives voted to change the age at which retirement savers must start taking money out of most retirement accounts. The new age is 75, up from 72. For those who will have to take Required Minimum Distributions (RMDs), that’s good news, right? Maybe.
While the House bill still needs to be passed by the Senate, there is strong bipartisan support for it and it looks likely to be signed into law. Here are the highlights for 401(k) plans:
· Required minimum distributions pushed from age 72 to 75
· Larger catch-up contributions for older workers--increased from $6,500 to $10,000
· Matching contributions allowed into Roth 401(k)
· Sign-up bonuses allowed
· Matching contributions allowed for employees paying off student loans
Currently RMDs must begin when a retiree reaches age 72, an increase from age 70½ three years ago. More time until the first RMD means you don’t have to start paying tax on those distributions. There are few ways to avoid taking RMDs. So, once you reach that age, these distributions must come out and they are 100% taxable at ordinary income tax rates.
The RMD surprise
For some savers with big 401(k)s or IRAs, their first RMD could be a surprise. For example, if you are 72 and had a 401(k) or IRA with a balance at the end of 2021 of $2 million, your first RMD will be $78,125. That amount will be added to any other ordinary income you receive such as Social Security benefits,1 pensions, or dividend or interest income. These sources of income are all taxed at higher rates than long-term capital gains.
Three more years
So, if you get three more years to defer income taxes on your first RMD, that’s good right? Well, not necessarily. One of the indirect consequences of delaying RMDs is that your account can grow more because: a) there are not RMDs coming out and b) your investments in your account can grow. Since the RMD calculation is based on your account balance on December 31st of the prior year-end, the bigger your balance, the bigger your RMD.
The problem of waiting too long and having too much
Also, you’re three years older when you take your first RMD which means that you’ll have three less years to take distributions. As such, distributions will be larger because the older you are, the more the IRS requires you to take out of your 401(k) or IRA. This could be a problem
because it effectively “back loads” RMDs to the last years of your life. Using the $2 million IRA above, if you retire at age 75 instead of 72, your first RMD could be $110,019—that’s $31,894 more of taxable income.2 For taxpayers who are close to the next tax bracket, it could mean a higher tax rate on their RMD.
Waiting to take RMDs and pay tax always seems like a good idea, right?
For some retirees, this is not a problem because they are going to need every penny in their 401(k)s and IRAs to cover their expenses. However, for upper income families and those with big IRAs, it could concentrate RMDs into a specific period and even push them into a higher tax bracket—just because they waited to start taking their RMDs.
The problem for beneficiaries
When a non-spouse inherits an IRA, they now have to take distributions from it over a nine-year period instead of over their life expectancy. This increases the amount that must be added to taxable income. It is especially problematic if you are in your highest earning years when you inherit a large IRA.
The bottom line is that planning the timing of retirement, distributions, and the types of retirement accounts (e.g., Roth IRAs vs. Traditional IRAs) can be crucial to higher income taxpayers that have large 401(k)s or IRAs.
Do you still have questions about RMDs? Give us a call. We’re here to help.
You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson Lyman@PlanWithFPS.com
617-653-3303
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Check out more blogs from us at www.PlanWithFPS.com/blog ·
Required minimum distributions https://planwithfps.com/blog/required-minimum-distributions
The IRA tax bomb and why Roth conversions are more important than ever https://planwithfps.com/blog/the-ira-tax-bomb-and-why-roth-conversions-are-now-more-important-than-ever
The year of the Roth conversion https://planwithfps.com/blog/2021-year-of-the-roth-conversion
1 A portion of Social Security benefits is non-taxable.
2 The future value of $2 million at a hypothetical average rate of return of 8% for three years.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.