required minimum distributions (RMDs)

The Downside of Delaying RMDs

With the SECURE Act 2.0, Congress is contemplating raising the age for required minimum distributions. However, don't assume you would benefit from this change if the legislation is passed.

It took more than four decades for congress to raise the age for required minimum distributions in 2019 from 70½ to 72. Less than two years later, Congress is considering raising it again.

The Setting Every Community Up for Retirement Enhancement Act of 2019 had bipartisan support, and experts believe that Congress's encore, the Securing a Strong Retirement Act -- already approved by the House Ways and Means Committee -- has a good chance of becoming law. Dubbed the SECURE Act 2.0, the bill aims to make it easier for Americans to save for retirement by raising the RMD age to 73 on Jan. 1, 2022; to 74 on Jan. 1, 2029; and then to 75 on Jan. 1, 2032.

Having three more years of tax-deferred growth in your retirement savings accounts, however, is a mixed bag. "Everyone likes when you delay RMDs," says Ed Slott, president of Ed Slott and Co., which provides IRA training to financial advisers. "But waiving RMDs or putting them off doesn't help most people."

In fact, taking RMDs later could hurt. The amount of these required withdrawals from traditional IRAs and 401(k)s is based on both the account balance at the end of each year and the account owner's life expectancy as determined by the IRS's Uniform Lifetime Table. By delaying RMDs, retirees may be forced to make bigger withdrawals from an account that is likely to have a larger balance because it had more time to grow. That can have tax implications.

Of course, raising the RMD age is appropriate given today's longer life expectancies. In the mid-1970s, when the Employee Retirement Income Security Act, or ERISA, first authorized IRAs, U.S. life expectancy at birth was 72.6 years, according to the Centers for Disease Control and Prevention. By 2020, that age, according to the CDC, had jumped to 77.3 years.

Raising the RMD age does give retirees more flexibility. If the law is changed, savers can still take distributions before age 75 or, if they can afford to, leave the funds alone a few more years. "This just gives you options but doesn't force you to do anything you don't want to do," says Catherine Reilly, director of retirement solutions at Smart USA, a retirement plan provider.

The delay also gives people more time to convert a traditional IRA to a Roth before RMDs kick in, which can have tax advantages. (You can still convert to a Roth after you start taking distributions, but before the conversion you must take your RMD for that year.) Roth IRAs have no RMDs, and because the accounts are funded with post-tax dollars, withdrawals in retirement are tax-free.

For most seniors, though, the proposed legislation is unlikely to matter. The Treasury Department estimated in 2019 that 20.5% of seniors required to take RMDs would withdraw only the minimum amount in 2021. That implies that most people taking RMDs need the money for living expenses and are unlikely to delay distributions if given the choice. "For the majority of retirees this will be a nonevent if [Congress] pushes the age back," says Paul Camhi, vice president at investment advisory firm The Wealth Alliance. "Most can't afford to wait until 72, let alone until age 75."

If you can afford to wait, be prepared for a tax hit. Because RMDs are taxed as income, taking a larger sum later could nudge you into a higher tax bracket. As a result, more of your Social Security benefits may be taxed or you could lose out on certain deductions and credits if higher RMDs push you past income requirements. Even Medicare premiums for Parts B and D, which are based on income, could be higher. "There are ripple effects from having more income," Slott says.

No matter what happens, don't assume that waiting to take RMDs is always better. Instead, calculate how your RMDs would change if you take them later. "Try and get the money out at the lowest tax rate possible," Slott says. "That may mean spreading the RMDs over more years to stay in a lower tax bracket. Pushing it back to 75 may not be doing yourself a favor long term."

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