Who benefits if the age requirement for retirement account withdrawals is raised

Some future retirees might end up having more time to amass a pile of cash that won’t be taxed when they or their heirs tap into it.

Under a provision of a federal retirement bill that was approved by the House of Representatives last month, required minimum distributions, or RMDs, of qualified accounts would eventually start at age 75, up from age 72 currently. . RMDs are amounts that must be withdrawn each year. of most retirement savings plans — that is, 401(k) plans or Individual Retirement Accounts — under federal law.

If the proposed RMD age change passes Congress, the benefit will go to those who wish to transfer assets to a Roth IRA from traditional 401(k) plans or IRAs.

While taxes apply to the converted amount, Roth accounts have no RMD for the life of the owner and qualified withdrawals down the road are tax-exempt – in stark contrast to 401(k) and traditional IRAs.

“Let’s say in the past, a person retired at age 65 and had seven years to make conversions — they would potentially have 10 years to make those conversions in a tax-efficient way,” said Certified Financial Planner and CPA Jeffrey Levine. , director of planning at Buckingham Wealth Partners in St. Louis.

“It’s a benefit for the wealthy, who are looking to use their IRA more as a wealth transfer account than a retirement account,” Levine said. “I don’t blame them, but that’s who really benefits.”

RMDs, which are determined by dividing your account balance by your life expectancy (as defined by the IRS), can be a thorn in the side of those who don’t need the money. In other words, they have enough income from other sources and prefer to let their investments continue to grow.

However, most account holders – 79.5%, according to the IRS – take more than their annual RMD.

Current law states that you must take your first RMD for the year in which you turn 72, although this first RMD can be delayed until April 1 of the following year. If you are employed and contribute to your company’s pension plan, RMDs do not apply to that particular account until you retire.

As mentioned, there is no RMD with Roth IRA during the lifetime of the account holder. However, for all inherited IRAs, 401(k) plans, or other qualified retirement accounts, the balance must be fully withdrawn within 10 years if the owner died after 2019, unless the beneficiary is the spouse or another eligible person.

The bipartisan retirement bill that was approved by the House last month (HR 2954) and awaits Senate action is known as “Secure 2.0” and aims to build on the original Secure Act. of 2019, which introduced changes aimed at increasing retirement security. This bill raised the age of RMD to 72 instead of 70 and a half.

The recent bill passed by the House would change when RMDs are to start by raising the current age from 72 to 73 next year, then 74 in 2030 and 75 in 2033. The Senate RMD proposal is a bit different: it would simply increase the age to 75 in 2032. It would also remove RMDs for people with less than $100,000 in aggregate retirement savings, and reduce the penalty for failing to take RMDs to 25% over to the current 50%.

“Reducing the missed RMD penalty to 25% seems reasonable, given that most errors come from [individuals] who don’t know the rules,” said CFP Mark Wilson, president of MILE Wealth Management in Irvine, Calif.

The graphs below illustrate the performance of a theoretical $500,000 portfolio over time, gaining 5% per year under an RMD age of 72 and 75. The difference at age 95 is $40,391 using the later RMD age.

As for those taking advantage of the time between retirement and the age at which RMDs begin to convert a traditional 401(k) plan or IRA balances into a Roth IRA, there may be times when you want to rethink this move.

“There are certainly a lot of people who use the years between, say, retirement at 65 and their RMD years to do conversions because their tax rate may be lower than when they were working,” said Levine.

For starters, if you plan to give a lot to charity, it may be beneficial to leave that amount in a traditional IRA. This is because when you reach age 72, you can give money directly from your IRA to charity – this can count towards your RMD for that year, up to $100,000 – and this so-called qualified charitable distribution is excluded from your taxable income.

“The charity does not pay tax on the [donation]so there’s no sense in doing a conversion and paying taxes,” Levine said, adding that the same is true if your estate plan includes leaving an IRA directly to a qualified nonprofit.

Another situation where it might make sense to leave money in an IRA is if you are in a high income tax bracket but your beneficiaries are in a lower tax bracket. In other words, if you’re paying a higher rate on the converted amount than the heir would pay after you die, it may make sense to leave it in a traditional IRA and have it taxed at the lower rate.

At the same time, however, keep in mind that many beneficiaries will only have 10 years to exhaust the account.