RMD 101, Tax Reform 2.0, and my Mom.
My mother still objects vehemently. These are her funds! She squirreled these away for years! She should be able to spend them – or not – as she deems appropriate! Who is the government to tell her she has to take money out of her retirement plan?!
Required Minimum Distributions (RMDs) are often seen as an annoyance for retirees age 70 ½ and up. Put simply, tax-deferred retirement assets aren’t generating revenue for the IRS- but, this doesn’t go on forever. The IRS insists that you actually take the money out of these accounts and pay taxes on them… AND The IRS has tools to make sure you comply. In the case of RMDs, compliance is encouraged through a 50% Penalty tax on any RMD that you should have taken, but did not.
Starting in the year you turn age 70 ½, the IRS requires that you take money from your tax-deferred retirement accounts. What you do with that money is your business, but generally you cannot simply turn it around and put it back into tax-deferred savings. As such, you’ll likely owe income taxes on the distribution.
How much do you need to take out? Some folks are of the opinion that the RMD amount is the product of a complex algorithm designed by NASA and requiring special math coprocessors to figure out. Others think there’s just an arbitrary number based upon how much revenue the government needs that year. Actually, the amount is the product of a simple division equation: Take the prior year-end balance in your account, and divide it by a ‘magic number.’
Finding that ‘magic number used to be a bit complicated. It was derived from the joint life expectancy of both spouses in a married couple, and the individual life expectancy of a single person, as published in appendix B of IRS Publication 590. Then, back in 2002, the IRS took a step to make finding this number a lot easier, by using one Uniform life table, used by nearly everybody. The only exceptions now are:
- Someone with a spouse more than 10 years younger than they are – these people can still use the Joint life expectancy table.
- Someone inheriting IRA assets may have the ability to stretch required minimum distributions over their lifetime, but they use a Single life table.
The RMD rules don’t ALWAYS apply, even for some folks over age 70 ½. Some exceptions are as follows:
- The first year you’re required to take RMDs, you can put them off until April 1st of the following year. Keep in mind that doing this does not allow you to put off your second year distributions, so it will result in a double distribution in year 2.
- You’re not required to take an RMD from an employer retirement plan like a 401(k) or 403(b) if you’re still working for that employer. You do, however, need to take a distribution for the year in which you retire, even if you retire on December 31 of that year!
- Roth IRAs are the one type of tax-deferred IRS qualified retirement account that does not require minimum distributions (although beneficiaries of Roth IRAs do have to keep up with RMDs!) Also, after tax (‘non-qualified’) annuities – those that aren’t IRA accounts- don’t have RMDs.
- While not an RMD exception, charitable-minded people subjected to RMDs can avoid taxation on up to $100,000 when they have their RMD paid directly to a qualifying charitable organization.
Interestingly, the life expectancy tables used by the IRS – the ones that were updated in 2002 – have not been updated since, even though life expectancy and average retirement ages have changed (slightly) since then. The Trump administration issued an executive order on August 31st, a small part of which would act to raise these factors slightly. Keep in mind, since we divide the year-end balance by this factor to calculate the RMD, a higher factor results in a lower RMD (and thus more of the benefits that come with tax-deferral).
Beyond the executive order, which we think has a good chance of being implemented in 2019 for use on 2020 RMDs, there is additional work being done by congress. The proposed legislation is commonly dubbed ‘Tax Reform 2.0”. A part of the proposed legislation is geared toward making the temporary provisions of the 2017 Tax Cuts and Jobs Act more permanent. Another objective is to further reduce the tax bite for retirees by modifying RMD rules. A number of ideas have been floated, ranging from omitting RMDs altogether for people with less than $50,000 in an employer plan, to moving the RMD beginning age to 25.
Will much of this proposed legislation see the light of day? If historical norms persist, most will not. Also, the mid-term elections may very well change the trajectory and viability of Tax Reform 2.0. Part of this program, called the Family Savings Act, would allow folks subject to RMDs to contribute to an IRA, basically allowing them to, at least partially, offset the taxable distribution with a deductible contribution. Keep in mind that, in order to make any IRA contribution, you would need to have earned income. Not many people over 70 ½ earn income these days- but, my mom does, so this could be good news for her.
Until then, she’ll continue to find limited satisfaction in her stubborn insistence: “They can force me to take it out, but they can’t force me to spend it!”
