A new law increasing the age you must withdraw from your retirement accounts could have some unexpected and costly consequences.
President Biden signed in December raising the age at which retirees must begin taking required minimum distributions, or RMDs, from IRAs, 401(k)s and 403(b) plans to 73 this year, from 72. That would increase to Age 75 in 2033. The delay allows investments to grow tax-free even longer and offers a window to dispose of more tax-deferred dollars.
But deferring your RMD can end up leaving you with larger required annual withdrawals later in life, pushing your income into a higher tax bracket, which can affect what you pay taxes on or for your Medicare premiums. This can also become a tax headache for the heirs.
“The further you get away from the RMD age, the shorter that period becomes to get all that money out,” Ed Slott, in New York and an IRA expert, told Yahoo Finance. “And because you’re taking in more income in a shorter period of time, you and your beneficiaries will generally pay more in taxes.”
You cannot hold funds in a retirement plan or traditional IRA (including SEP and SIMPLE IRA) indefinitely. Ultimately, they must be cashed out and taxed as ordinary income.
The new rule requires that once you reach 73, you have no choice but to start withdrawing money with an RMD, which is calculated by dividing your tax-deferred retirement account balance as of December 31 of the previous year by the life expectancy factor which corresponds to your IRS age As your life expectancy decreases, the percentage of your assets that must be withdrawn increases.
Under the new law, account holders who fail to take RMDs face a 25% penalty on the amount not distributed, down from 50%. And if you fix it quickly, the penalty goes down to 10%.
If you have other taxable income in addition to your Social Security benefits, such as your RMD, it may affect the amount of your benefit.
If you file a federal tax return as an individual and your combined income — your adjusted gross income plus tax-free interest you earned on investments plus half of your — is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If you earn more than $34,000, up to 85% of your benefits can be taxable.
For those of you who file a joint return and have total income between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. If your total income is more than $44,000, up to 85% of your benefits may be taxable.
Also, if you delay withdrawals, your RMD based on your declining life expectancy will be larger, and if tax rates increase, you’ll end up paying a bigger tax bill.
“The trade-off is that there could potentially be higher RMDs later, and guessing what future income tax rates will be is quite a risk. If they’re higher in the future, they’ll be worse off than if they took them earlier,” said Eileen O’Connor, a certified financial planner and co-founder of said Yahoo Finance.
Slott had a similar opinion.
“People who don’t need the money think they’re saving something by delaying RMDs,” Slott said. “But in the long run, they may end up paying more in taxes by waiting until 73 and taking only minimum distributions.”
The potential impact on Medicare premiums
Simply put, if you have a higher income, you may have to pay an extra premium for Medicare Part B and Medicare for prescription drugs. Standard rates increase for individuals with MAGI above $97,000 and for married couples with MAGI of $194,000 or more.
Heirs can feel the sting too
“Delaying RMDs can create a more difficult planning environment if heirs are involved, as they must empty inherited IRA distributions within 10 years,” O’Connor said.
The reality is that the more money you leave in a retirement account for your heirs to inherit, the greater the tax burden on them. They are likely to inherit when they are likely to be in the highest tax bracket of their lives during their peak earning years. As a result, they will pay more taxes.
Kerry is a senior reporter and columnist at Yahoo Finance. Follow her on Twitter @kerryhannon.
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