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Some future retirees could end up getting more time to amass a heap of money that won’t be taxed when they or their heirs tap it.
Under a provision in a federal retirement bill that cleared the House of Representatives last month, required minimum distributions, or RMDs, from qualified accounts would eventually start at age 75, up from the current age of 72. RMDs are amounts that must be withdrawn annually from most retirement savings — i.e., 401(k) plans or individual retirement accounts — under federal law.
If the proposed RMD age change makes it through Congress, the benefit would go to those who want to move assets to a Roth IRA from traditional 401(k) plans or IRAs.
While taxes apply to the amount converted, Roth accounts have no RMDs during the owner’s lifetime and qualified withdrawals down the road are tax-free — which is in stark contrast to traditional 401(k) plans and IRAs.
“Say in the past a person retired at 65 and had seven years to do conversions — they’d potentially have 10 years to do those conversions in a tax-advantaged manner,” said certified financial planner and CPA Jeffrey Levine, chief planning officer at Buckingham Wealth Partners in St. Louis.
“This is a benefit for the wealthy, looking to use their IRA more as a wealth-transfer account than a retirement account,” Levine said. “I don’t begrudge them, but that is 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 coming from other sources and would rather let their investments continue growing.
However, most account holders — 79.5%, according to the IRS — take more than their yearly RMD.
Current law says you have to take your first RMD for the year in which you turn age 72, although that first RMD can be delayed until April 1 of the following year. If you’re employed and contributing to your company’s retirement plan, RMDs do not apply to that particular account until you retire.
As mentioned, there are no RMDs with Roth IRAs during the account owner’s lifetime. However, for all inherited IRAs, 401(k) plans or other qualified retirement accounts, the balance must be entirely withdrawn within 10 years if the owner died after 2019, unless the beneficiary is the spouse or other qualifying individual.
The bipartisan retirement bill that cleared the House last month (H.R. 2954) and is awaiting Senate action is known as “Secure 2.0” and is intended to build upon the original Secure Act of 2019, which ushered in changes aimed at increasing retirement security. That bill raised the RMD age to 72 from age 70½.
The recent House-passed bill would change when RMDs must start by raising the current age 72 to 73 next year, and then 74 in 2030 and age 75 in 2033. The Senate’s RMD proposal is a bit different: It would simply raise the age to 75 in 2032. It also would waive RMDs for individuals with less than $100,000 in aggregate retirement savings, as well as reduce the penalty for failing to take RMDs to 25% from the current 50%.
“Reducing the missed RMD penalty to 25% seems reasonable, given most errors are from [individuals] who aren’t aware of the rules,” said CFP Mark Wilson, president of MILE Wealth Management in Irvine, California.
The charts below illustrate how a theoretical $500,000 portfolio would perform over time, earning 5% annually under an RMD age of 72 and age 75. The difference at age 95 is $40,391 using the later RMD age.
As for those who take advantage of the time between retirement and the age when RMDs start to convert a traditional 401(k) plan or IRA balances to a Roth IRA, be aware that there may instances when you want to rethink that move.
“There are certainly a lot of people who use the years between, say, retirement at age 65 and their RMD years to do conversions because their tax rate may be less than when they were working,” Levine said.
For starters, if you plan to give a lot to charity, it can be beneficial to leave that amount in a traditional IRA. This is because when you reach age 72, you can donate money directly from your IRA to a charity — it can count toward your RMD for that year, up to $100,000 — and this so-called qualified charitable distribution is excluded from your taxable income.
“The charity doesn’t pay tax on the [donation], so there’s no sense in doing a conversion and you paying taxes,” Levine said, adding that the same goes if your estate plan includes leaving an IRA directly to a qualified nonprofit.
Another situation where it could 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’d pay a higher rate on the converted amount than what the heir would pay after your death, 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 have just 10 years to deplete the account.