The House Ways & Means Committee is once again tinkering with the law that requires retirees to take minimum distributions from their individual retirement accounts (IRAs) and 401(k)s. Each time, Congress eases the required minimum distribution (RMD) rules at great cost to the federal government. Yet the beneficiaries would overwhelmingly be wealthy retirees and their future heirs.
The committee bill, approved today, would make two big changes to RMDs. It would allow retirees to wait until age 75 before taking required minimum annual distributions and paying tax on them. Currently, they must begin taking distributions at age 72. And it would make it easier for older adults to avoid taking required distributions by investing their retirement funds in annuities.
The new RMD rules are included in the Securing a Strong Retirement (SECURE) Act of 2021. To be sure, the measure would make some beneficial changes, including provisions that encourage more employers to auto-enroll workers in retirement plans, an important tool to encourage participation. But it also includes some clunkers, and the RMD rules are high on the list.
Congress can’t help fiddling with the RMD rules.
In December, 2019, Congress allowed workers to delay taking RMDs from age 70.5 to age 72. Last year, Congress waived minimum distributions entirely in response, it said, to the pandemic. Lawmakers felt it would not be fair to require retirees to take distributions after the stock market plunged in March, 2020. Except, whoops, the S&P index rose 16 percent for the year.
Now SECURE would gradually extend the delay to 75. It would rise to 73 in 2022, then 74 in 2029, and finally 75 in 2032. But don’t be surprised if a future Congress accelerates the timetable.
Remember, the purpose of tax-free retirement plans is to help older adults save for their, um, retirement. It was not supposed to be another tool for bequests to family members. RMD rules are intended to make sure that these assets are taxed during a person’s expected life. Without the rules, rich retirees could simply stash assets in tax-advantage accounts until they die, then pass them on to heirs.
Delaying RMDs again would have major consequences, some unintended. And it would not be cheap. At a time when lawmakers say they are worried about growing deficits, delaying RMDs would reduce federal revenue by almost $7 billion over 10 years. But the real cost would begin once the age phases up to 74 in 2029. At that point, revenue would fall by about $1.4 billion annually.
But its biggest problem is that delaying RMDs would be so regressive.
In 2015, the roughly 17 percent of taxpayers with adjusted gross incomes of $100,000-plus took more than half of the $253 billion in IRA distributions. Those making $50,000 or less took only about 20 percent.
In 2019, the median retirement account balance was only about $65,000, according to the latest Federal Reserve’s Survey of Consumer Finances. Another survey found that nearly one-third of people in their 60s or older had less than $100,000 in defined contribution plan assets.
No help to many
Many low-income retirees with such limited retirement assets already take more than the required minimum annually to pay routine bills. Delaying required distributions would not benefit them in any way.
Keep in mind, as well, the life expectancy for low income people is far lower than for the wealthy. The RMD delay also is of no benefit for those who die before age 73.
It is the same story with enhanced annuities. Retirees with relatively little wealth receive few benefits from these investment. Someone investing that median $65,000 at age 65 would get an average payout of only about $250 a month.
Charities may be unintended losers from these changes. They benefit from another complicated provision called qualified charitable distributions (QCDs). By contributing required distributions to charity, seniors can avoid tax on mandatory withdrawals. And QCDs have become a popular way for wealthy seniors to donate to charity.
It appears that these gifts fell sharply in 2020, largely in response to the temporary waiver of RMDs. And it would be no surprise if they continue to fall if wealthy seniors can delay distributions until age 75.
Some heirs are required to close, and pay tax on, their inherited IRAs within 10 years, although spouses and minor children and exempt from that requirement. Even for those subject the 10-year rule, the long deferral can be extremely valuable.
The Biden Administration is proposing a major shift in the tax treatment of assets held outside of retirement accounts by taxing at death unrealized capital gains in excess of $1 million. By doing so, it would prevent wealthy people from passing on a large share of their wealth tax free.
The RMD change in the SECURE Act, by contrast, would make it easier for wealthy seniors to pass on retirement plan assets, with any tax liability delayed for years.
I am author of the book “Caring for Our Parents” and senior fellow at The Urban Institute, where I am affiliated with the Tax Policy Center and the Program on Retirement Policy. I also write a tax and budget policy blog, TaxVox, which you may read at Forbes.com or at http://taxvox.taxpolicycenter.org/ Before joining Urban, I was a senior correspondent in the Washington bureau of Business Week.
For more information on IRAs, including required withdrawals, see:
- Required Minimum Distributions (RMDs)
- Individual Retirement Arrangements (IRAs)
- Required Minimum Distribution Worksheets for IRAs
- Chart of required minimum distributions for IRA beneficiaries
- Publication 560, Retirement Plans for Small Business (SEP, SIMPLE and Qualified Plans)
- Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)
- RMD Comparison Chart (IRAs vs. Defined Contribution Plans)
- What are Required Minimum Distributions?
- What types of retirement plans require minimum distributions?
- When must I receive my required minimum distribution from my IRA?
- How is the amount of the required minimum distribution calculated?
- Can an account owner just take a RMD from one account instead of separately from each account?
- Who calculates the amount of the RMD?
- Can an account owner withdraw more than the RMD?
- What happens if a person does not take a RMD by the required deadline?
- Can the penalty for not taking the full RMD be waived?
- Can a distribution in excess of the RMD for one year be applied to the RMD for a future year?
- How are RMDs taxed?
- Can RMD amounts be rolled over into another tax-deferred account?
- Is an employer required to make plan contributions for an employee who has turned 70½ and is receiving required minimum distributions?
- What are the required minimum distribution requirements for pre-1987 contributions to a 403(b) plan?
How is the amount of the required minimum distribution calculated?
Generally, a RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor that IRS publishes in Tables in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). Choose the life expectancy table to use based on your situation.
- Joint and Last Survivor Table – use this if the sole beneficiary of the account is your spouse and your spouse is more than 10 years younger than you
- Uniform Lifetime Table – use this if your spouse is not your sole beneficiary or your spouse is not more than 10 years younger
- Single Life Expectancy Table – use this if you are a beneficiary of an account (an inherited IRA)
See the worksheets to calculate required minimum distributions and the FAQ below for different rules that may apply to 403(b) plans.