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6 RMD Changes We Could See This Year
Congress is on a bit of a roll these days. Despite deep political divisions within the country, they've managed to send several major bills to the president's desk so far this year addressing semiconductor manufacturing, veterans' benefits, gun safety, climate change, and more.
And they might not be done yet. Lawmakers in Washington are currently considering two separate bills that would make substantial changes to how Americans save for and are taxed in retirement. And one of the major areas of focus in these bills is reforming RMDs (i.e., required minimum distributions).
The SECURE Act, which was enacted in 2019, extended the age at which you must start taking RMDs from 70½ to 72. That was a big boost for seniors, who can now keep money in their tax-free retirement accounts longer. But that wasn't enough help for retirees in the eyes of many lawmakers. So, as soon as the ink was dry on the SECURE Act, a few key members of Congress began planning additional legislation to help more people save for retirement and hold on to their money longer in retirement.
Those efforts resulted in two bills that are now before Congress: the SECURE Act 2.0 and the EARN Act. The SECURE Act 2.0 was passed by the House of Representatives in March with a 414 to 5 vote. The EARN Act was introduced in the Senate in September. Both bills would make significant changes to RMDs, but there are differences in the two bills' RMD provisions.
Many experts believe the odds of passing a major retirement bill before the end of the year look promising. But we don't know yet which bill, if any, has a better chance of becoming law. So, the wise move at this point is to familiarize yourself with the potential changes in both bills. And for retirees or those approaching retirement who are worried about mandatory retirement account distributions, that means getting up to speed on the six possible RMD changes included in the two bills.
As it stands right now, you must start taking RMDs from 401(k) accounts, traditional IRAs, and similar retirement savings accounts (other than Roth IRAs) in the year you turn 72 (although you have until April 1 of the following year to take your first RMD). However, both the SECURE Act 2.0 and EARN Act would push the age for starting RMDs to 75. They would make the change in different ways, though.
Under the SECURE Act 2.0, the shift would be gradual, but start quickly. Starting in 2023, the age for taking RMDs would jump from 72 to 73. Then, starting in 2030, it would creep up again to 74. And, finally, it would rise to 75 in 2033.
With the EARN Act, the change would happen suddenly, but not right away. The RMD age would remain 72 through 2031, but it would then leap straight to 75 beginning in 2032.
There are steep penalties for failing to take an RMD. If you miss an RMD or don't take enough out of your retirement account, and you'll be hit with a 50% excise tax on the distribution shortfall. There is some penalty relief available, though. You may be able to avoid the additional tax if your failure to take an RMD was due to "reasonable error" (e.g., a serious illness) and you withdraw the necessary amount from your retirement account quickly.
The current 50% tax is one of the heaviest penalties in the entire tax code, so it's no wonder legislators want to bring it down. Both the SECURE Act 2.0 and the EARN Act would reduce the penalty to 25% in all cases. In addition, they would both drop the penalty down to 10% if you take the necessary RMD by the end of the second year following the year it was due.
If, for example, you failed to take an RMD that was due in 2022, the penalty would be knocked down to 10% if you withdrew the necessary funds by December 31, 2024. Under both bills, if the legislation were to be enacted this year, the penalty reduction provisions would apply beginning in 2023.
For some people, the SECURE Act 2.0 would also delay the start of the statute of limitations for assessing the penalty. Instead of starting the three-year limitations period when the tax return for the year at issue was filed – which could be later than the normal due date – it would start on the date that the return would have been required to be filed (excluding any extensions) for people who weren't required to file an income tax return for that year. By starting the clock sooner, some people could avoid the penalty if the IRS is slow in assessing it.
There are no RMDs for Roth IRAs. However, RMDs are currently required for Roth 401(k) accounts. You can get around the Roth 401(k) RMD rules by rolling over the money into a Roth IRA. But watch out for the Roth IRA five-year rule – if you're not careful, you may have to wait five years to pull your money out of the Roth IRA.
If enacted, the EARN Act would do away with the need to roll over funds from a Roth 401(k) to a Roth IRA. Instead, as with Roth IRAs, Roth 401(k) accounts wouldn't be subject to the RMD rules before the account holder dies. (Post-death minimum distribution rules, which also apply to Roth IRAs, would still apply.) This change would generally kick in starting in 2024; however, an exception would apply to RMDs required before 2024 but not required to be paid until January 1, 2024, or later.
The SECURE Act 2.0 and EARN Act would address a few issues related to the use of annuities with retirement savings accounts. For instance, if a retirement account includes an annuity, the account is split under current law between the part holding the annuity and the part that doesn't for purposes of applying the RMD rules. This can result in higher RMDs. The EARN Act would immediately allow you to combine distributions from both parts when calculating your annual RMD amount.
The IRS also has rules that restrict how the annuity payments can be made if the annuity is issued in connection with a retirement plan. As noted in a SECURE Act 2.0 summary from the House Ways and Means Committee, the rules are generally designed to "limit tax deferral by precluding commercial annuities from providing payments that start out small and increase excessively over time." However, these restrictions often discourage people from including an annuity in their retirement accounts.
To help make annuities a more attractive component of retirement plans, both the SECURE Act 2.0 and EARN Act would allow the following payments if certain requirements are satisfied:
This change would be effective starting in 2023 under the SECURE Act 2.0, but would be effective immediately upon enactment under the EARN Act.
Finally, the SECURE Act 2.0 and EARN Act would boost the use of qualifying longevity annuity contracts (QLACs). Generally, with a QLAC, you can invest up to $130,000 (2022 amount) or 25% of a retirement account, whichever is less, and shield those funds from RMDs. Both bills would repeal the 25% limit and clarify that (1) survivor benefits can be paid following a divorce, and (2) an employee has 90 days from the purchase date to rescind a QLAC. The EARN Act would also bump the dollar amount up to $200,000 (adjusted for inflation each year). Repealing the 25% limit and increasing the dollar amount would apply starting the day after legislation was enacted. The clarifying language would apply retroactively to any QLAC purchased on or after July 2, 2014.
Special rules currently exist for determining when a surviving spouse has to start taking RMDs from an inherited retirement account. One of those rules states that, if an account holder dies before RMDs are required and his or her surviving spouse is the beneficiary (and doesn't change that status), RMDs from the inherited account aren't required until the year in which the deceased account holder would have reached age 72.
The EARN Act would tweak this rule by also allowing the surviving spouse to be treated as the deceased account owner for RMD purposes starting in 2024. In some cases, this would allow the surviving spouse to delay taking RMDs from the inherited account – e.g., if the surviving spouse is younger than the deceased spouse.
The surviving spouse would have to elect this treatment according to procedures the IRS would have to establish, and the election would be irrevocable. He or she would also have to notify the account administrator.
Money donated to charity through a qualified charitable distribution (QCD) counts towards your RMD. So, for charitable minded seniors, QCDs are a great way to reduce the amount of money you otherwise have to withdraw from an IRA. However, QCDs are capped at $100,000 per year…and that amount doesn't go up each year.
Both the SECURE Act 2.0 and the EARN Act would allow the $100,000 limit to be adjusted annually for inflation (rounded to the nearest $1,000). Under the SECURE Act 2.0, adjustments would begin in 2023, but they wouldn't start until 2024 under the EARN Act.
In addition, both bills would allow a one-time QCD of up to $50,000 to charities through certain charitable remainder annuity trusts, charitable remainder unitrusts, or charitable gift annuities. If enacted in 2022, the SECURE Act 2.0 version would apply for the 2022 tax year, while the EARN Act version wouldn't apply until 2023.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.