On May 23rd the House of Representatives passed a bill “Setting Every Community Up for Retirement Enhancement” or SECURE for short. While the name is a little zany, this bill would make some of the biggest changes to retirement policy in over 10 years. The bill is expected to get fast-tracked in the Senate, as SECURE is receiving bipartisan support, evident by the wide margin in which the bill passed (417-3). The bill does include some changes for current workers, but the biggest impact would be on current retirees, and those approaching their retirement date.
Required Minimum Distributions
If you’re not familiar with the concept of Required Minimum Distributions (RMDs), currently every retiree when they reach the age of 70 ½ must start to take money from their retirement accounts, whether they want to or not. In my experience with helping retirees with their RMDs, there’s a fair amount of confusion around the requirements. Even the age at which folks must start taking the RMD is strange because the month you are born in has an impact on which year you must start taking.
Take this year as an example: if you were born on June 30, 1949, you will turn 70 ½ before the end of 2019, and so this will be the first year that you must take your RMD. However, if you were born just 24 hours later on July 1, 1949, you don’t need to take your first RMD until next year, 2020. To add even more confusion, the mathematical formula would be different for these two people, even though for both of them it would be their first RMD ever!
The formula used to determine the minimum amount that must be taken from the account is complicated: first, you must total the values of all of your retirement accounts from December 31st of the previous year. You then must refer to an IRS table that assigns a percentage to take from the account that is based on the age of the retiree.
(Note: ROTH IRAs are exempt from RMD rules unless the ROTH is inherited. This is part of the reason that a ROTH can be a valuable tool when trying to balance a retiree’s spending needs and taxes.)
At age 70 ½ the percentage is equal to about 3.65% of your total retirement account balances as of December 31st from the previous year. When you turn 71, that percentage increases to 3.77% of your account balances; at age 72 it increases again to 3.9%. Every year you get older, the percentage of your account that you must withdraw increases. In fact, if you lived to be 115 years old, the minimum you would have to withdraw would be equivalent of 52% of your account!
Many retirees complain about the RMD, because every dollar that is taken out of an IRA is treated as taxable income. As they age, (and the percentage increases dramatically) they can find themselves in higher and higher tax brackets regardless if they need the money or not. This is precisely why the RMD was created, because the government wants to collect some of the taxes before the account is passed on to presumably younger generations.
Proposed changes to RMDs
Congress is well aware that many Americans do not have enough saved for retirement, and that many Americans are working into their 70’s. Part of the current proposal in the SECURE bill is to increase the first age that a retiree has to take a RMD to age 72. This would eliminate the strange June/July birth month example from above and it would result in a standard RMD calculation for everyone.
One outstanding question: Will they also change the formula?
This remains to be seen, and nothing I’ve read (including the actual bill) mentions it. Recall that currently a 70 ½ year old must take 3.65% from their account and a 72 year-old will have to take 3.9%. I would love to think that Congress will change the formula and adjust the percentage, but we will have to wait and see. The cynic in me thinks they will keep the formula the same, which means while the retiree gains a year or two via the delay, once they reach age 72, the amount will be identical. This also means that any current retiree who has already started taking their RMD won’t be helped by this new rule change, which is extremely unfortunate. I feel that they won’t change the formula because the impact to the Federal Budget could be dramatic: some analysis I’ve read says it could cost the Treasury as much as $8.9 Billion in tax revenue over the next 10 years if passed. Any changes to the formula would just increase that impact on tax revenue.
There is another proposed rule change in the bill that would offset some of that loss of tax revenue. This is a discussion for another blog, but essentially once a retirement account is inherited by anyone other than a spouse, the new rule would require that person take their inheritance out in a quicker fashion than current rules allow. If SECURE passes and becomes a bill we will be sure to inform folks of the change. My belief is while the bill in its current form may not pass, I do believe they will pass some retirement reform. There is just too much support from both parties to help American retirees make their hard-earned savings last longer not to fix some of these rules that haven’t changed in decades.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.