Before we get to why I believe that we should finally put an end to the outdated and unnecessary Required Minimum Distribution (RMD) rule, it is important to see how we got here. In 1986, as the popularity of the use of IRAs, 401(k)s and rollover IRAs grew, Congress began to become worried that these tax-deferred accounts would be used as multi-generational tax shelters for the ultra-wealthy.
Congress argued that these types of accounts were to be used for the employees’ retirement, not the retirement of their kids and grandchildren and that a rule was needed to ensure that the funds were not passed down over and over. The solution was the RMD rule which became law with the passage of the Tax Reform Act of 1986. We cannot ignore the real driving force behind the law: the government wanted the tax revenue and wanted it sooner rather than later. Both the need to ensure the one-percenters don’t pass on an IRA over and over, and the tax revenues are at the crux of why I believe we should end this outdated rule now.
What is the Required Minimum Distribution rule?
For younger readers who may be unfamiliar with what a RMD is, allow me to explain.
Once a retiree reaches age 72, they MUST begin taking money from most tax-deferred retirement accounts. (Think 401(k)s/IRAs/403(b)s etc. -whether they need the money or not!)
(Note: ROTH IRA and ROTH 401(k)s are exempt and part of the reason they can be a useful tool in retirement planning and estate planning).
The amount of money the retiree must take out of their IRAs is not a set dollar amount. There is a formula that every year the retiree must use to calculate the amount they have to take out.
The first part of the formula is based on the age of the retiree. The older the retiree, the more they must take out of their retirement assets on a percentage basis. The second part of the formula is based on the amount of assets held in those eligible accounts as of December 31st of the previous year. The more money you have, the greater nominal distribution. And just to remind everyone, every dollar that comes out of these accounts is taxable income, so the more you take out, the more taxes you owe.
For example, at age 72 the amount a retiree must take out is almost equal to 4% of their IRA assets, and it grows sequentially every year. By age 100, a retiree would have to take out almost 16% of their retirement assets to meet the Required Minimum Distribution!
RMDs in 2020
As soon as the COVID pandemic hit, the government started announcing programs to support the economy and Americans. They announced that RMDs could be skipped for 2020, meaning that retirees do not have to take money out this year if they do not want to. This is not the first time this has happened; in fact, it is not even the first time since I’ve been working at StrategicPoint! The last time was in 2009, during the last recession. If the government knows it can afford to suspend taking RMDs twice in eleven years, what does that tell you about their ability to suspend the RMDs entirely? To me it says a lot, because they know that the move to suspend the RMDs doesn’t help the majority of retired Americans.
The question of how many Americans take out only the required amount is actually not an easy thing to identify. However, according to this Fidelity article they state that “the U.S. Treasury Department estimates that only 20.5% of RMDs in 2021 will be for the minimum amount.”
That means the remaining 80% of retirees over the age of 72 are taking out more than the RMD amount to support their lifestyle in retirement. If this fact is true (and I have spent time trying to determine how the US Treasury came up with that estimation but have had no luck), then the whole RMD rule is nothing but an annoyance for most seniors!
So, if the government knows that most people either want to (or have to) take money out of their retirement accounts, why keep the RMD? Well remember that they were originally afraid that the ultra-wealthy would find other ways to fund their retirement, and then leave the IRAs to their children and grandchildren. If they were successful, then suddenly an IRA could conceivably grow tax-deferred for 50 to 60 years! By requiring that folks must start to take money out, and then increasing that percentage every year, it was guaranteeing themselves tax revenue AND making it extremely unlikely that an IRA could last for 50-60 years.
Why I believe they can end the need for RMDs now
Lost, or at least pushed to the background due to the COVID pandemic, was the passage of the SECURE act in December 2019. For those unfamiliar with the SECURE Act, one key aspect was that with limited exceptions, once a non-spouse inherits any type of retirement account, that account must be emptied within ten years, or the owner will face a stiff penalty. On average, most people are going to leave their IRA’s to their kids, so once the children inherit an IRA from Mom or Dad, they must take that money out (pay the income taxes on it) and the inherited IRA must be empty before the 10th year.
This slight rule change ensures that IRAs can no longer be passed on to multiple generations! This was the primary driving force for creating the RMD rule in the first place, and now it’s been all but eliminated so let’s get rid of the RMD entirely!
Now there will be those who say the government will never go for this because they need the tax revenue. As I have already shown, twice in the past decade they have suspended the program and according to their estimates as many as 80% of Americans are still going to need to take money out to live anyways, so the impact would be minimal in my opinion. However, there will be those who say, “You are trying to help out the ultra-wealthy by delaying when they pay their taxes! You are just trying to help the rich get richer!” to which I say let us think this out first.
If we do away with the RMD rule, and the ultra-wealthy defy the odds and never tap their IRAs, what happens? At some unavoidable point, those IRA assets will be inherited by someone who has the 10-year clock ticking to empty the account. Any actuarial could take pen and paper and prove my next point, but if the average mortality rate of an American is 80 and the average American has kids as they approach 30, what age will their beneficiaries be when they inherit the assets? Most likely they will be around 50, which is the prime earning years for most workers, which means they probably are in a higher tax bracket than their parents. Now they will have to add extra income via distributions to meet the 10-year rule, and those taxable distributions will be added on top of their earned income. It is impossible for me to envision a situation where many beneficiaries are in a lower tax bracket then their retired parents, and so if I am correct this rule is costing us tax revenue from the ultra-wealthy.
The original RMD rule served two major purposes: ensuring that the government get tax revenue from these accounts now and preventing multi-generational tax-deferred growth. With the passage of the SECURE act, it’s legally impossible to pass an IRA on for many generations and tax revenues will probably go up if the next generation inherits more assets. There is simply no reason to maintain this rule anymore and it should be eliminated in my professional opinion.
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.