We have good news! The IRS has reduced the amount that you “must” distribute from your IRA each year. If you are an IRA or 401(k) owner currently in your seventies or older, you are probably well aware of the RMD. RMD stands for Required Minimum Distribution, or the minimum amount you must withdraw from your account each year as mandated by the IRS. Generally, you must start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 72 (70 ½ if you reached age 70 ½ before January 1, 2020).
The concept of why RMDs exist is intuitive, especially from the perspective of the IRS! You have been setting aside dollars pre-tax into your IRAs and 401(k)s, in many cases for several decades. The earnings—capital gains, dividends, interest—also accumulate within those accounts without being reduced by taxes over time. At some point, now age 72, the government comes back to recapture that missed tax revenue. Withdrawals from these pre-tax retirement accounts are taxed as ordinary income.
Your RMD amount is based on the value of your retirement account on December 31 of the previous year and the age you will attain in the current year. The RMD is equal to that account value divided by a number based on that age. The IRS calls that number the “life expectancy factor,” and it can be found under the Uniform Lifetime Table (Table III) in Appendix B of IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). This number decreases with age, meaning the percentage one needs to withdraw from their IRA increases over time. For illustrative purposes, below is a truncated example assuming a $1 million IRA balance at various ages under the Uniform Lifetime Table through 2021 and the new table factors, effective January 1, 2022. The full table itself goes all the way to age 115.
At a high level, less money will have to be withdrawn by owners of retirement accounts. In November 2020, the IRS issued new life expectancy tables. These new tables are effective January 1, 2022. This was the first change in the RMD tables since 2002 and was intended to reflect the improvement in mortality rates over that period. The new tables will result in a moderate reduction in RMDs from the current tables. See the comparison below.
|Uniform Lifetime Table Calculations|
|Through 2021||2022 & beyond|
As you can see, the new table provides a small reduction in taxable income each year. Like compounding, the reduction becomes more meaningful when considered over several years or decades.
This change is most helpful to those who do not rely on their RMD to supplement their retirement living expenses and prefer to keep their adjusted gross income (AGI) low. This could apply to households where their guaranteed income, via pensions and Social Security perhaps, covers a sizable portion of their retirement expenses and goals. It can also apply to those with ample after-tax and/or Roth assets they can draw from more tax-efficiently to meet their needs. Lowering AGI not only lowers the income taxes you pay but can have the added benefit of possibly reducing the effects of ancillary taxes, such as Medicare IRMAA.
Of course, there can be other more impactful ways to offset the current or future sting of the taxable income that RMDs create, such as Qualified Charitable Distributions or Roth Conversions. Please see the commentaries shown under “See More” below for additional detail
Please note that this commentary focuses on individuals for whom the Uniform Lifetime Table applies when calculating RMDs. This is the table used by most retirement account owners. There are two other life expectancy tables, the Joint & Last Survivor Table and the Single Life Table, which apply in specific and limited situations. These tables have also been adjusted by the IRS, resulting in lower RMD calculations.
While this change is not dramatic by any means, it does represent a reduction in the amount of taxable income retirement account holders are forced to assume each year starting at age 72. Flexibility is a good thing. Please know your advisors at Bragg are paying attention and prepared to share relevant changes when they become law. As always, thank you for choosing Bragg Financial Advisors and do not hesitate to reach out if you would like to discuss your specific planning situation.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.