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Some future retirees may end up having more time to accumulate a pile of money that will not be taxed when they or their heirs lose them.
According to a provision in a federal pension law that approved the House of Representatives last month, required minimum distributions or RMDs from qualified accounts would eventually begin at age 75, up from the current age of 72. RMDs are amounts to be deducted annually from most pension savings – ie. 401 (k) schemes or individual pension accounts – under federal law.
If the proposed RMD age change comes through Congress, the benefit will go to those who want to move assets to a Roth IRA from traditional 401 (k) plans or IRAs.
While taxes apply to the converted amount, Roth accounts have no RMDs in the owner’s lifetime, and qualified downtime withdrawals are tax-free – in stark contrast to traditional 401 (k) plans and IRAs.
“Say earlier that a person retired at age 65 and had seven years to perform conversions – they would potentially have 10 years to perform those conversions in a tax-benefit manner,” said Certified Financial Planner and CPA Jeffrey Levine, Planning Manager at Buckingham Wealth Partners in St. Louis.
“This is a benefit for the wealthy who want to use their IRA more as a wealth transfer account than a retirement account,” Levine said. “I do not default on them, but they are the ones who really benefit from it.”
RMDs, which are determined by dividing your account balance by your life expectancy (as defined by the IRS), can be a thorn in the side of those who do not need the money. In other words, they have enough revenue from other sources and would rather let their investments continue to grow.
However, most account holders – 79.5% according to the IRS – take more than their annual RMD.
The current law states that you must take your first RMD for the year in which you turn 72, although the first RMD may be deferred until April 1 of the following year. If you are employed and contribute to your company’s pension scheme, RMDs do not apply to that account before you retire.
As mentioned, there are no RMDs with Roth IRAs during the life of the account owner. However, for all inherited IRAs, 401 (k) schemes or other qualified retirement accounts, the balance must be fully withdrawn within 10 years if the owner died after 2019, unless the beneficiary is the spouse or another qualified person.
The double pension law that cleared Parliament last month (HR 2954) and awaits Senate action is known as “Secure 2.0” and is intended to build on the original Secure Act of 2019, which heralded amendments aimed at increasing pension security . That bill raised the RMD age to 72 from the age of 70½.
The latest bill passed by Parliament would change when RMDs have to start raising the current age 72 to 73 next year and then 74 in 2030 and 75 years in 2033. The Senate RMD proposal is a bit different : It would simply raise the age to 75 by 2032. It would also waive RMDs for people with less than $ 100,000 in total retirement savings, as well as reduce the penalty for failing to take RMDs to 25% from the current 50%.
“Reducing the lost RMD penalty to 25% seems reasonable, as most errors are due [individuals] who are not aware of the rules, “said CFP Mark Wilson, president of MILE Wealth Management in Irvine, California.
The charts below illustrate how a theoretical portfolio of $ 500,000 would perform over time and earn 5% annually below an RMD age of 72 and 75 years. The difference at age 95 is $ 40,391 using the later RMD age.
For those who take advantage of the time between retirement and age when RMDs begin converting a traditional 401 (k) plan or IRA balances to a Roth IRA, be aware that there may be cases where you will reconsider this move.
“There are definitely a lot of people who use the years between, say, retirement at age 65 and their RMD years to make conversions because their tax rate may be less than when they worked,” Levine said.
First, if you are planning to donate a lot to charity, it may be beneficial to leave this amount in a traditional IRA. This is because when you reach the age of 72, you can donate money directly from your IRA to a charity – they can count in your RMD for that year, up to $ 100,000 – and this so-called qualified charity is excluded from your taxable income.
“The charity does not pay taxes [donation]so there is no point in making a conversion and you are paying taxes, “Levine said, adding that the same is true if your property plan includes handing over an IRA directly to a qualified nonprofit.
Another situation where it might make sense to leave money in an IRA is if you are in a high-income tax bracket but your recipients are in a lower tax bracket. In other words, if you would pay a higher rate on the converted amount than what the heir would pay after your death, it might make sense to leave it in a traditional IRA and get it taxed at the lower rate.
At the same time, keep in mind that many recipients will only have 10 years to use up the account.