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 or more time for strategic tax planning — 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 And though your annual RMD can be withdrawn in a lump sum, you can also opt to space out disbursements each month or over quarterly payments.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. 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% (10% if corrected within the “Correction Window”). 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.
This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Please note, changes in tax law or regulations may occur at any time and could substantially impact your situation. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was created by The Oeschli Institute to provide information on a topic that may be of interest.