The Security Act 2.0 gives savers 72 and under an extra year before having to withdraw money from their retirement accounts. But just because you can defer required minimum distributions (RMDs) doesn’t mean you necessarily should, financial advisors say.
Passed late last year, the sweeping retirement law raised the RMD age to 73 in 2023 from 72. Starting in 2033, the RMD age will increase to 75.
The changes most immediately affect those turning 72 this year, who would otherwise be required to take their RMDs by April 1, 2024. (The Internal Revenue Service is giving first-time enrollees a grace period until the spring the following year; in all subsequent years, RMDs must be taken by the end of the year.) Your RMD is calculated by dividing your retirement account balance as of December 31 of the previous year by what the IRS calls your “expectancy ratio of life”. The amount received is reported as income; you must withdraw it from your account and you will owe taxes on it. RMD rules apply to traditional IRAs as well as employer-sponsored retirement plans such as 401(k)s and 403(b)s.
Most Americans do not have the luxury of waiting, as they need withdrawals from their retirement accounts to live. But among those who can afford to wait, delaying isn’t always the best move. If you delay your RMD and your retirement account balance increases, you’ll need to withdraw a larger amount the following year. (Even if your account balance stays the same, you’ll need to take out more because your life expectancy factor will be lower.) The extra income can increase not only the amount you pay in income taxes, but your Medicare premiums down the line.
“Some of the old rules of thumb, like letting your tax-deferred accounts marinate as long as possible, don’t always apply,” said Josh Strange, a certified financial planner and president of NOVA’s Good Life Financial Advisors in Alexandria, Va. .
Without a crystal ball showing how the markets will perform this year, it’s impossible to say whether current 72-year-olds might benefit from delaying RMDs by a year, all other things being equal. (Market participants surveyed by Barron’s expected the S&P 500 to end the year higher than its current level). But what if all other factors are not equal? Let’s say you’re 72, expect to retire this year and be in a lower tax bracket next year. In that case, deferring RMDs until 2024 would probably make sense. On the other hand, if you plan to sell your primary home in the next year and realize more than $250,000 in capital gains (or $500,000 if you’re married filing jointly), then you may want to start your RMDs this year to avoid possibly a larger RMD to be added to next year’s income along with your capital gains. This could lead to higher Medicare premiums for you down the line.
Rather than waiting until you’re at the RMD threshold to do tax planning, you’ll have a better chance of managing the tax consequences if you start years earlier. “The sooner the better,” said Chris Yamano, a partner at Crewe Advisors in Scottsdale, Arizona. One popular move is to do a Roth conversion after you retire but before you reach RMD age. You’ll likely be in a lower tax bracket during that time, so converting your traditional IRA to a Roth IRA — either all at once or spread over several years — will mean you’ll owe less tax on the converted amount than if you had it when you were in a higher group.
It can also benefit from withdrawing from your retirement accounts before you planned. For example, if taking withdrawals earlier would allow you to delay claiming Social Security until age 70 to receive your full benefit, then that might be worth considering. Lawrence Kotlikoff, an economics professor at Boston University who sells software to optimize Social Security, run a script of a hypothetical high-income couple in their early 60s who plan to retire and claim Social Security at age 64. The couple lived in New York and planned to wait until age 75 to take their RMDs. Using his MaxiFi software, he found that waiting until 75 would be less tax-efficient for this couple than starting smooth withdrawals at age 64, because their reduction in New York state taxes and premiums Medicare will exceed the increase in federal taxes they owe from earlier withdrawals.
“It’s a very complicated calculation,” Kotlikov said. “It’s really very individual specific.”
Write to Elizabeth O’Brien at [email protected]
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