Q. A few weeks ago, you wrote about SECURE 2.0 and some of the impactful provisions of the new law. Among them, you mentioned how the age when Required Minimum Distributions (RMDs) would need to start has increased to 73 for individuals who turn 72 after December 31, 2022. You also indicated that ten years from now, the required minimum distribution age will increase again, to age 75, but only for individuals who turn 74 after December 31, 2032. I fit into that group and am wondering — are these delays in RMDs really a positive thing? Thanks for your help!
A. Thank you for your question about Required Minimum Distributions (RMDs). I’ll start with a little background about how RMDs came to be and explain why these delays are not necessarily a positive thing and what you can do about it.
A Bit of a History of RMDs
Retirement accounts were originally created to encourage Americans to save for retirement while working. These retirement accounts were given tax advantages, either tax-deferred growth or, in the case of a Roth account, tax-free growth. However, the government wanted people to eventually spend these accounts to fund retirement, so they put in rules requiring mandatory beginning dates for RMDs.
Originally, the government chose age 70½ as the general starting point when you had to start taking distributions from retirement accounts. Due to people living longer and the risk cost of retirement, Congress passed the SECURE Act in 2019, which pushed out the required beginning date to age 72. Now, in 2023, with the passage of SECURE 2.0, RMD changes again loom large. For more details on these changes, our readers can refer to my recent article on the subject.
SECURE 2.0 and RMDs: A Brief Summary of Provisions
Here is a brief summary of the changes affecting RMDs. Click here for detailed section-by-section descriptions.
- Push Back RMDs to Age 73 and then 75: Section 107 of the SECURE 2.0 Act pushes the required beginning date (RBD) for participants of qualified retirement plans and IRAs to start taking RMDs.
- Remove Roth Account Pre-Death RMDs: Under current law, RMDs are not required prior to the death of the owner of a Roth IRA, and this rule has not changed. However, RMDs have been required for those who own a Roth account that’s part of an employer retirement plan. For example, owners of a Roth 401(k) or a Roth 403(b) account have been required to take RMDs. Section 325 of the SECURE 2.0 Act removes this pre-death RMD requirement, putting Roth 401(k) and Roth 403(b) on the same footing as Roth IRAs. Both Roth IRAs and Roth accounts continue to be subject to post-death RMD rules, which do not change under this new provision. This will start in 2024.
- Reduction of Missed RMD Penalty Tax: Section 302 of the SECURE 2.0 Act reduces the penalty for missing an RMD from a 50 percent penalty tax to a 25 percent penalty tax. Additionally, if the RMD is corrected in a timely fashion, it would reduce the penalty down to 10 percent.
- Removed Barriers for Life Annuities, Expansion of QLACs, and RMD Rules: Section 201 of the SECURE 2.0 Act removes a few barriers for life annuities in qualified plans and IRAs that have arisen due to the actuarial test required in calculating RMDs with annuities. This change would allow annuities to offer an increasing payment if that payment is a “constant percentage” increase at least annually and no more than 5 percent increase a year.
- Eliminating RMD Increase on Partial Annuitization: Section 204 of the SECURE 2.0 Act allows for participants to elect aggregate distributions from both portions of a retirement account in order to determine if the distributions meet the RMD rules.
There Are Potentially Significant Downsides to Delaying RMD Distributions
Per your question, today we’ll focus on Section 107, the provision that delays when someone must start taking required minimum distributions. The delay is positive in that it allows investments to grow tax-free for longer than before and provides a window to put more tax-deferred dollars away. There are some potentially significant downsides, though:
- Paying More Income Tax and Higher Medicare Premiums During Your Lifetime: Postponing taking RMDs is likely to ultimately result in you being forced to take larger and larger required annual distributions later in life, as your life expectancy declines over time, quite possibly pushing your annual income into a higher tax bracket that may significantly increase what you pay in income taxes over the course of these required withdrawals, which can also negatively impact what you pay for your Medicare premium because of the fact that your Medicare premium is always based on your taxable income from two years prior.
- Beneficiaries Paying More Income Tax After Your Death: Postponing taking RMDs means that it is more likely that you will still have retirement account money remaining upon your death, which your beneficiaries are generally required to take out (and of course pay taxes on) over a period of 10 years from your death. This is quite often during the time when your beneficiaries are in their peak earning years and are already in a high tax bracket, so the RMDs from your inherited retirement account push them into an even higher tax bracket, again possibly resulting in greater overall taxes paid than if you had started taking earlier distributions from your retirement accounts while you were alive.
- Paying More Tax on Your Social Security Benefits: If you have taxable income in addition to your Social Security benefits, such as your RMD, that can impact how much your Social Security benefit is taxed.
- If you file a federal tax return as an individual and your combined income — your adjusted gross income, plus nontaxable interest you have earned on investments, plus one-half of your Social Security benefits — is between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your Social Security benefits. If you earn more than $34,000, up to 85 percent of your Social Security benefits may be taxable.
- For those of you who file a joint return and have a combined income between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your Social Security. If your joint income is more than $44,000, up to 85 percent of your Social Security benefits may be taxable.
What You Can Do
Take Distributions Earlier Using Tax Bracket Management
Despite the new law allowing you to postpone taking required minimum distributions until you are older, many people may wish to take their distributions earlier, even earlier than age 70½. As most people know, if you take retirement account distributions prior to age 59½, there is a 10 percent penalty if you don’t return those funds within 60 days. However, it is extremely important to understand that there’s no penalty for taking IRA distributions once you have turned age 59½ — you just have to pay ordinary income tax.
Pay Less Tax Using Tax Bracket Management
Depending on when you retire and the amount of your income (whether or not you’re retired), the best time to take IRA distributions may be between age 59½ and age 63, because IRA distributions after age 59½ are not subject to penalty, and taking these distributions prior to age 63 will never affect your Medicare premium because you’re not yet enrolled in Medicare (remember that your Medicare premium is based on your income from two years prior).
As an example, I met with a married couple just in the past few weeks who had both retired around age 60 and had very significant funds in their IRAs and other very significant financial holdings and other retirement income, causing them to already be in the 35 percent tax bracket. They were planning to wait until their required beginning date (RBD) to take their RMDs but I explained to them what I just explained in the previous paragraph, and they decided to take it out all of their retirement account money now, before age 63, as it was only going to increase their tax bracket to the top 37 percent tax bracket, a mere 2 percent difference, that’s greatly reducing their overall lifetime income taxes and reducing what they pay for their Medicare premiums for the rest of their lives.
Even after age 63, it may be most tax efficient to start taking distributions from your retirement accounts in order to minimize the total amount of taxes you pay.
As an example, I meet with clients every day who are already in the 22 percent tax bracket, meaning that all income withdrawn from a taxable retirement account will be taxed at a minimum rate of 22 percent. Optimal tax bracket management often involves withdrawing funds from your taxable retirement account(s), potentially over several years, in order to bring your income to the top of the 24 percent tax bracket, thus locking in these low 22 percent and 24 percent tax rates (both of these tax rates are scheduled to go up in 2026). The money withdrawn can then be used to fund a Roth IRA (there are no limits on these types of “back-door” Roth contributions) or, often better for our Level 3 clients, to put this money into the Living Trust Plus® Asset Protection Trust. More on this below.
(The tax bracket management strategies discussed above are not financial advice and are not intended to be used as the sole basis for financial decisions. Financial advice and specific strategies must be designed to meet the particular needs of your specific situation. Numerous factors should always be considered, in consultation with your attorney, your financial advisor, and your CPA, and tailored to your specific goals and the relative weight you assign to each specific goal).
Fund Your Living Trust Plus®
There is even more reason now for individuals wanting asset protection to cash out their IRA funds (perhaps over several years to lessen the taxes, using tax bracket management for the settlor) to fund a Living Trust Plus® Asset Protection Trust. The Living Trust Plus® allows you to protect assets from probate, PLUS lawsuits, PLUS Veterans Benefits (after three years) for qualified wartime veterans, PLUS Medicaid (after five years).
For more details on why it is often better to take our money from IRAs and put the after-tax amount into a Living Trust Plus, click here.
Now Is the Time to Make Revisions to Your Estate Planning Documents
SECURE 2.0 may have a significant impact on some estate and retirement plans. Current clients who are members of our Lifetime Protection Plan® and others who have IRAs need to immediately reevaluate their estate plans, including all beneficiary designations.
Plan in Advance for Retirement
With the new RMD landscape and other changes in the law, the need for retirement planning and estate planning remains more important than ever. Besides being a Certified Elder Law Attorney, I am also an experienced retirement planning advisor and long-term care financial advisor through my affiliation with Protection Point Advisors. If you have not done your Estate Planning or Retirement Planning or had your Planning documents and Retirement Plan reviewed in the past several years, please don’t hesitate to call us as soon as possible for an initial consultation:
Estate Planning Fairfax: 703-691-1888
Estate Planning Fredericksburg: 540-479-1435
Estate Planning Maryland: 301-519-8041
Estate Planning DC: 202-587-2797
About Evan H Farr, CELA, CAP
