Retirement Income Planning
What do a pandemic and Congress have in common? They have both thrown financial plans for a loop this year. First, it was the SECURE Act. Then it was a pandemic and the CARES Act. And, now, another change is on its way.
Be prepared for a few tweaks to your retirement income plans.
For most, a retirement account is a critical component to a retirement strategy. But the government is a partner in your accounts too. The deal is tax-deductible contributions and tax-free growth. So at withdrawal, Uncle Sam gets his cut and taxes are due.
When you take a withdrawal from a retirement account, you are taxed. Early withdrawals come with penalties. Eventually, everyone must begin taking minimum withdrawals when they hit a certain age (Roth IRA excluded). We call them required minimum distributions.
Required minimum distributions (“RMDs”)
According to the IRS, RMDs are minimum amounts that a retirement plan account owner must withdraw each year. Some exceptions apply, but for most of us, this withdrawal period begins at age 72.
The rules around RMDs have changed a lot in the last year.
First, it was the SECURE Act, a major bill that passed at the end of 2019. It upended the tax code and changed the age at which RMDs start. For everyone turning 70 ½ after January 1, 2020, the new RMD age is 72. Everyone 70 ½ before January 1, 2020, has already started their RMDs.
Then the pandemic hit and the markets crashed. In response, Congress passed another major bill: the CARES Act. This bill waived the minimum distribution requirement for 2020. Since RMDs are based on year-end account values, it seemed, at the time, that retirees would be required to make a huge withdrawal on a now much lower portfolio value.
Now, the RMD formula is set to change effective January 1, 2022.
How an RMD is calculated
Retirement accounts come with required withdrawals. Uncle Sam, our silent partner in this transaction, wants his piece! And he is serious about taking what he is owed. Missing a required distribution may result in very steep penalties – 50% of undistributed funds!
Every year, we whip out our calculators to make sure, down to the penny, that every RMD is taken. Here’s how to verify annual amounts:
First, sum total the value of all your retirement accounts at the previous yearend. (Note: Roth IRAs do not have minimum distribution requirements.)
Second, look up your age in the IRS’s Uniform Life Table. Next to your age is a “factor.” Write this down.
Third, divide your total year-end IRA balance by your factor. This is your required minimum distribution for the year. (Note: Married IRA owners with spouses younger than 10 years use a different table.)
2020 and 2021 will use the same table. Starting in 2022, there will be a new Uniform Life Table. So, one year from now, throw out your old ones. They’ll be obsolete. The good news? The amount of required distribution is decreasing relative to the size of your IRA accounts.
How the RMD changes affect you
An example can help illustrate the change. Let’s take a person turning 75 in 2021 who has a total IRA balance of $500,000 on December 31, 2020. Their RMD will be $21,834.06 under the soon-to-be obsolete Uniform Life Table.
When using the new Uniform Life Table in 2022, the RMD for a 75-year-old with a $500,000 retirement account will be $20,325.20. That is a decrease of approximately $1,500.
While the changes seem minor, there may be changes to personal budgets going forward!
If your budget in retirement is Social Security PLUS your annual required minimum distribution, then your monthly “paychecks” may feel a little light. If Social Security and other income cover your lifestyle costs and the required minimum distribution was being used as a retirement bonus to travel, shop, or give gifts, then briefly revisit those plans.
Please contact us and schedule a time to talk if you’re wondering how RMD changes affect you.
Planning Your Retirement Income
Life expectancies are increasing. The longer we live in retirement the greater the chance we outlive our money. Therefore, when planning for income from your portfolio, we need to make sure it lasts as long as we do. The changing RMD formula is an adjustment for society living longer.
There are two ideas you can think about today.
First, if your IRA distributions are reset each year based on your required minimum distributions, re-calculate expected amounts to start in 2022. See if you need to re-configure spending in 2021 to prepare. Use this handy table from Kitces.com for estimating. Of course, if you’re already taking distributions that are greater than the required amount, a changing RMD formula won’t impact you much.
Second, if you only take the RMD each year, there is an increased chance of money being leftover for your beneficiaries. The SECURE Act made it a requirement that all (some exceptions apply) non-spouse inheritors withdraw IRA funds within 10 years of death. It might be useful to consider the tax impacts on your beneficiaries and make changes.
As always, when it comes to retirement income planning there is a lot to consider. We want you to be informed and in charge of your finances. Please contact us and let us know how we can help you understand all the recent changes.