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Why the SECURE Act Makes 2020 the Year of Missed RMDs From IRAs
With Congress agreeing to pass the SECURE Act, which represents the first major retirement legislation since the Pension Protection Act of 2006, the required minimum distribution (RMD) rules that impact retirement savings accounts are changing drastically.
Essentially, the SECURE Act made two major changes to the RMD rules:
Let’s look at the potential impact of these new changes as it relates to extending the required beginning date to age 72.
What Changed with the RMD Required Start Date?
Due to people working longer, Congress pushed out when required minimum distributions begin. For anyone who has not already reached age 70.5 by the end of 2019, the new required beginning date will be 72 for RMDs. There is an exception to this rule if you are not a 5% owner in the company and continue to work, you can push out your RMDs for that employer’s retirement plan until the year after you retire.
Typically, once you hit your required beginning date for RMDs, now 72 for most situations after the SECURE Act, you have to take your first RMD by at least April 1 of the year after you reach 72. So, if you reach age 72 in 2021, you need to take your first RMD by April 1, 2022. The RMD for any year is typically the account balance as of the end of previous year (Dec. 31) divided by a distribution period from the IRS’s “Uniform Lifetime Table.”
Who will this new change impact? First, as pointed out by Jeff Levine, the push of the RMD beginning date from 70.5 to 72 will mostly benefit those who have not yet turned 70.5 and are born in the first half of the year. The reason is because if you turn 70.5 in the second half of the year, you won’t hit age 72 for two more years. However, for those that hit 70.5 early in the year, the change will only push RMDs by one year.
For example, let’s say your birthday is Oct. 15. If you were expected to hit age 70.5 in 2020, on April 15 (tax day), and you reach age 71 on Oct. 15, then new rules would only push out your required beginning date from 2020 to 2021.
However, if your birthday was instead on April 15, and you did not reach 70.5 until Oct. 15, 2020, then you would not turn age 72 until 2022, essentially pushing out your required beginning date by two years.
EBRI examined this type of change, coupled with increasing the Uniform Lifetime Table life expectancies. In fact, the IRS just released in November 2019 proposed updates to the Life Expectancy and Distribution Period Tables, which if finalized, would also provide some relief to retirees by reducing the amount of RMDs owed each year to allow money to last longer in retirement. According to the EBRI report, it appears that a one- to two-year change in RMD beginning date would only have perhaps a 2% to 4% change in total RMDs. As such, while it will have some impact, it would be quite small. If life expectancies are also changed, EBRI saw it could have an impact on decreasing RMDs by up to 8%.
Why is 2020 A Year of Lost RMDs
So, if you turn 70.5 by the end of 2019, you will need to start taking RMDs for 2019. The first one needs to come out by April 1, 2020. However, if you turn 70.5 after Jan. 1, 2020, you now won’t be required to take an RMD for 2020. In fact, no one will be required to take a 2020 RMD based on turning 70.5 in 2020 or turning 72 in 2020.
It will really be a lost year of required beginning dates for RMDs based on age. Instead, anyone turning 70.5 in 2020 won’t hit age 72 until 2021 or 2022. This means their first RMDs will now have to be out of the account by either April 1, 2022 (if you reach age 72 in 2021) or by April 1, 2023 (if you reach age 72 in 2022).
Potential Tax Implications
One of the critiques of this rule change is that it will mostly only benefit wealthier Americans who do not need all of their required minimum distributions right now, allowing them to have a year or two more of tax-deferred savings. If you retire before 70.5—like most Americans—you likely already started taking withdrawals from your retirement accounts to meet your retirement income needs. As such, many Americans withdraw more than their RMDs require each year. So, a push back in the year they must start will have a minimum impact on most Americans.
On the other side, the push back in RMD age could cause negative tax consequences in some limited situations if no planning is done. Because the RMD won’t start for some individuals until two years later, the RMD could be higher than if they started at 70.5. As such, a higher RMD can mean more taxable income.
By increasing taxable income, the individual could be pushed into a higher tax rate or even trigger increased Medicare premiums. Medicare’s Income Related Monthly Adjustment Amount (IRMAA) is determined by modified adjusted gross income. And $1 over the threshold means you pay the higher Medicare amounts, meaning that $1 extra of taxable income could cost thousands in Medicare premiums. So even just a slightly higher taxable RMD could cause problems.
A part of retirement income planning is to look at projected RMDs and understand when to start and the best way to take these amounts out. There are a lot of strategies to minimize the tax implications of potentially higher RMDs.
Qualified longevity annuity contracts (QLACs) can be used inside of IRAs and 401(k)s to reduce RMDs and providing longevity protection. Qualified Charitable Contributions (QCDs) can be used from an IRA to send money directly to a charity and meet an RMD requirement but avoid the amount being treated as taxable income. And strategic Roth conversions can be used to move taxable IRA money into a Roth IRA that won’t be subject to RMDs at 72, providing more control over your income.
While there are lots of strategies out there for RMD planning, any strategy needs to be considered in context of a comprehensive plan that takes into consideration your entire tax situation, savings, goals and retirement plan. Making RMD decisions in a silo is not the best way to go. So, if you believe these new rules might impact your retirement planning, reach out to a qualified financial professional to help you incorporate the new changes into your plan.
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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.