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 31rst 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 And though your annual RMD can be withdrawn in a lump sum, you can also opt to space out disbursements each month or over quarterly payments.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.
SOURCES:
Townsend,Michael. “Congress Passes Major Boost to Retirement Savings”. December 23, 2022.https://www.schwab.com/learn/story/congress-passes-major-boost-to-retirement-savings
Mengle, Rocky. “ New RMD Rules_ Starting Age, Penalties, Roth 401(k)s, and More _ Kiplinger’. Dec. 23, 2022 https://www.kiplinger.com/retirement/new-rmd-rules
Taylor, Kelley R. “Retirement Savings Plan Rules Changed By SECURE 2.0 Act _ Kiplinger”. 3, 2023https://www.kiplinger.com/retirement/bipartisan-retirement-savings-package-in-massive-budget-bill
Internal Revenue Service. “Retirement Plans FAQs regarding Required Minimum Distributions _ Internal Revenue Service”.23-Sep-2022 https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum- distributions#:~:text=Generally%2C%20a%20RMD%20is%20calculated,Individual%20Retirement%20Arrangements%20(IRAs)
Centers for Disease Control and Prevention. “Life Expectancy in the U.S. Dropped for the Second Year in a Row in 2021’. August 31, 2022 https://www.cdc.gov/nchs/pressroom/nchs_press_releases/2022/20220831.htm
Steward, Jackie. “The Downside of Delaying RMDs _ Kiplinger“. December 26, 2022. https://www.kiplinger.com/retirement/downside-of-delaying-rmds
Information provided by Valorem Financial and written by Oechsli a non-affiliate of Cetera Advisor Networks, LLC and CWM, LLC.
Distributions from traditional IRA’s and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty. Converting from a traditional IRA to a Roth IRA is a taxable event. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.
This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
[1] Centers for Disease Control and Prevention, “Life Expectancy in the U.S. Dropped for the Second Year in a Row in 2021,” 2022.
