For Americans saving for retirement in traditional IRAs and 401(k)s, a significant rule change in those plans may be on the horizon.
President Donald Trump on Aug. 31 signed an executive order directing the Department of the Treasury to, among other mandates, investigate raising the age when retirement savers must begin taking so-called required minimum distributions (RMDs) from their traditional IRAs and 401(k)s. It’s a change that, if implemented, could be a big deal for your retirement plan.
WHAT IS AN RMD?
If you are saving for retirement in a traditional IRA or 401(k), the IRS requires you to begin withdrawing a minimum amount of money each year from those accounts once you reach age 70 ½. The amount you are required to withdraw is calculated based on the total balance held in those accounts — the more you hold the more you must take out. If you don’t make the withdrawals, you typically get nailed with a stiff penalty that’s equal to 50 percent of the amount you should have taken out.
The RMD rule was created to ensure people don’t accumulate tax-advantaged retirement accounts that they simply pass down as inheritance after their death, which would allow for decades more tax-free growth. RMDs basically limit the tax benefit of your 401(k) or IRA and ensure the IRS can collect some income tax revenue after letting your savings grow tax-free all those years.
WHAT HAS TRUMP PROPOSED?
There are no specifics at this point, but Trump has given the Treasury six months to investigate increasing the age these RMDs kick in. The Treasury department bases the RMD age on life expectancy tables calculated by government actuaries, and the last time the RMD age got bumped up was in 2002, when the average life expectancy was 77. Today, that’s closer to about 78 ½.
The U.S. Chamber of Commerce, for example, has suggested pushing the RMD age out to 75, or 4 ½ years further out into the future. The Chamber of Commerce says current RMD rules haven’t kept pace with a labor market in which people are living and working longer.
WHAT IT MEANS FOR YOU
RMDs are a bit of a tax headache, especially for high-income retirees and retirees who have money tucked away in multiple savings vehicles with different tax treatments. Income in retirement from a Roth IRA is tax-free and isn’t subject to RMD regulations. A retiree, therefore, may want to lean more on this asset for income to minimize their marginal tax rate. However, if they also have an IRA or 401(k), their taxable income will be bumped up due to those mandatory, taxable withdrawals.
Apart from the tax implications, delaying the age RMDs kick in could also boost the total amount retirees save. Adding just a few more years of tax-free growth could really add up for people who have amassed significant savings and are nearing retirement age. Let’s say you have $1 million tucked away in a 401(k) and you conservatively expect a 5 percent annual return, based on your investment mix. Simply letting that money sit another two years, without adding a single cent, could equate to an additional $102,500 available for retirement. That’s nothing to sneeze at.
However, the other side of the coin is that those RMDs down the road could be that much larger due to the higher balance that may accrue.
Again, Trump’s executive order doesn’t guarantee any of these changes are coming. However, it’s something to keep an eye on as we await the Treasury’s findings.