New RMD Rules May Allow Retirees to Hold onto More Savings
Starting in 2022, the IRS has extended life expectancy
tables for required minimum distributions (RMDs). As a result, retirement
account holders will be able to take out a smaller percentage of their IRA to
fulfill RMD rules.
An RMD is the amount of money retirement account holders must pull out from their 401(k), 403(b), or individual retirement account every year, starting at age 72 (or 70 ½ if you reached that age before January 1, 2020). The RMD amount is calculated as a portion of account size, and the distribution is taxed as normal income. (RMD rules do not apply to Roth IRAs.)
Important reminder: RMDs can be complicated for anyone to
understand — and any rule change just adds to the complexity. Furthermore, the
IRS assesses a stiff, 50% penalty tax on RMD amounts that should have been
taken but aren't. So, it would be wise to consult a tax
professional to discuss your, or your loved ones', specific circumstances.
What is the rule update?
The reason for the IRS's RMD rule change is actually quite
heartening — Americans are, on average, living longer lives. And since RMD
amounts are based on life expectancy, the IRS decided to slightly adjust distribution
requirements, effectively allowing retirement accounts to last longer.
Note: this discussion will focus on the IRS's Uniform
Life Table, since it applies to most retirees (unmarried IRA owners, married
IRA owners whose spouses are not more than 10 years younger, and married owners
whose spouses aren't the sole beneficiaries of their IRAs). However, rules differ
for beneficiaries taking RMDs from an inherited IRA.
Click here to view the Uniform Life Table
changes beginning 2022.
For most retirees, the change will be simple. For example,
take Tim who turns 76 years old in 2022 with an IRA balance of $300,000 as of
December 31, 2021. Under the IRS's old Uniform Life Table (the most commonly
used table), Tim would have had a life expectancy factor of 22, so would have
been required to take an RMD of $13,636.36 ($300,000/22). But under the new
Uniform Life Table, Tim's (longer) life expectancy factor is 23.7, so he will
take an RMD of $12,658.23 ($300,000/23.7). That means he would be allowed to
hold onto an additional $978.13 in his account compared to the old rules.
When calculating your RMD amount, some may find it
helpful to use an online calculator — like this one from AARP.
How the Rule Change Affects First-Time RMDs
The new rule has a notable quirk that affects people who
reached the age of 72 in the second half of 2021 (birthday from July 1, 2021 —
December 31, 2021) - the age at which people are required to begin taking RMDs.
This group is required to take their first RMD by April 1, 2022, using the old tables (the IRS allows a few extra months to pay your first RMD, but all
others are due by December 31). However, their 2022 RMD, due December 31, 2022,
would be calculated using the new tables.
For example, Noella reached the age of 72 on November 1,
2021, meaning she must begin taking RMDs. Since her birthday is in the second
half of the year, her first RMD is due April 1, 2022, and will use the old life
expectancy factor — in this case, 25.6. Assuming a retirement account balance
of $600,000 as of December 31, 2020, Noella would be required to take a 2021 RMD
of $23,437.50 ($600,000/25.6).
For her 2022 RMD, Noella will have to calculate her amount
based on her new (longer) life expectancy factor. Since she will turn 73 in
2022, her life expectancy factor on the new tables will be 26.5. If her
retirement account value on December 31, 2021, was $575,000, she would be
required to take a 2022 RMD of $21,698.11 ($575,000/26.5).
The latest RMD rule change comes after other recent acts
that impacted retirees. In 2019, Congress passed the SECURE Act, which raised
the RMD age from 70 ½ to 72. Then, in 2020, the CARES Act — passed in response
to the COVID-19 pandemic — waived RMDs for 2020. Due to all the changes,
retirees have been forced to adhere to different rules for 2020, 2021, and
2022. Therefore, we feel compelled to again point out that it would be wise to
speak to a tax professional or financial advisor for guidance.