SECURE ACT 2.0: What The New RMD Rules Mean For You

March 16th, 2023 by Blake Pinyan

Required Minimum Distributions (RMDs) have been in effect for almost 40 years. They were born from the Tax Reform Act of 1986 and originated with a starting age of 70-1/2. The basic principle is that one typically receives a tax benefit on the front end when contributing to a pre-tax retirement account. Because you receive the upfront deduction, the IRS taxes him/her on the back end. This back-end tax is forced annually once the account holder reaches a certain age. It’s a way for the IRS to start collecting revenue on deferred income.

The problem that the IRS ran into prior to 1986 was individuals, especially those who didn’t need the money, would not withdraw from their accounts. As a result, the IRS wasn’t getting paid.  This led to the enactment of the RMD rule. It states those with qualified retirement accounts must withdraw a certain amount of money each year once reaching a specified age.

This amount is determined upon three factors:

1. Age of the account holder
2. Account balance as of the last day of the previous year (12/31/2022 for 2023 RMD)
3. Published life-expectancy tables by the IRS

It’s a simple calculation to determine one’s RMD amount for the year:

• Balance of your account (as of the previous year-end) / the respective number on the life-expectancy tables (figured by your age) = your RMD amount.
• The higher the account balance and the older someone is, the larger their RMD and vice versa.
• A lower account balance and younger account holder would mean a smaller RMD.

Nowadays, most institutions that hold assets (Charles Schwab, Fidelity, etc.) compute the annual RMD on the client’s behalf. Manual RMD calculations are rarely done, especially since there are many online calculator tools.

The specified age stayed at 70-1/2 for over 30 years. It was only within the last 5 years that it has experienced significant change. In December of 2019, the passage of the first SECURE ACT increased it to 72 starting in 2020. Now, with SECURE ACT 2.0, the age has been further modified. This time, it’s not as black and white. I’ll explain the new structure and the planning implications that come along with it.

It took over 30 years for the age to move from 70 and a half to 72. 72 has only been the norm for a mere 3 years, and now we have a different schedule to abide by. The language of the new law is confusing, which is why the easiest way to understand it is by referencing your birth year. Here’s your guide.

Birth Year	RMDs Begin At
1950 or earlier	72 or 70.5 (if reached age 70.5 prior to 2020)
1951 – 1959	73
1960 or later	75

 

This means that there are no “new” RMDs in 2023.

• Those that turn 73 this year would have already taken their first RMD last year (when the specified age was 72).
• Those that turn 72 this year, they won’t be required to start taking withdrawals until 2024.

It’s anyone’s guess as to why they picked these ages at these years. We are here to help interpret those new rules and advise on the Financial Planning Opportunities which arise as a result. There are a couple positives and a negative with this RMD change.

The Good News

Starting with the good; the delay in the RMD age could lead to:

1. Additional Roth IRA Conversion Opportunities
2. Potentially Lower Medicare Premiums

Additional Roth IRA Conversion Opportunities

A Roth Conversion is when you transfer money from a Pre-tax IRA to a Roth IRA. The amount that is moved over is taxable in the year of transfer, but it paves the way for future tax-free growth and withdrawals. You are essentially paying tax today on the seed, with the expectation that the money will grow into a larger amount down the road at harvest time that is withdrawn tax-free.

This conversion achieves two objectives – it builds up the Roth and reduces the IRA balance. The latter is what impacts one’s determined RMD.

Specifically:

• The year-end balance of a qualified account (such as an IRA) is part of the formula for the RMD computation.
• The higher the account balance, the larger the RMD, and vice versa.
• The larger the RMD, the more taxes are paid.

RMDs are fully taxed at ordinary income rates, so a lower RMD would mean fewer taxes paid. Hence, the reduction of an IRA balance from Roth Conversions could lead to the reduction of one’s future taxes.

Once again, a lower IRA balance caused by Roth Conversions can mean lower RMDs and potentially lower tax liability. Knowing this fact, we place an emphasis on implementing the Roth Conversion tax strategy during the window of someone’s retirement to the age that they start taking RMDs. Our end goal is to save our clients’ money on their future taxes. Let’s look at an example.

• Sue retires at age 65.
• Prior to SECURE ACT 2.0, her specified RMD age was 72.
• Our window then to do some serious Roth Conversion planning would be from Sue’s ages of 65-72.
• Now, with the new legislation, our timeline has been expanded to either 73 or 75, depending upon Sue’s birth year. We now have an additional year or three to do Roth Conversion planning for Sue, which could save her more money on her future taxes.

Potentially Lower Medicare Premiums

Medicare Part B and D premiums are based upon an individual’s adjusted gross income (AGI) from two years prior. For example, costs for 2023 will be determined from the 2021 tax return. Like our tax system, the premiums are progressive. Therefore, the higher your income, the more premiums you’ll pay. This is the result of IRMAA (Income-Related Monthly Adjustment Amount). IRMAA says that once your income exceeds a certain threshold, you are bumped into the next tax tier and consequently, face surcharges on your premiums.

This ties into RMDs because they are required and fully taxed at ordinary income rates. So, your income, in theory, should be more in the years that you are drawing RMDs and less in those you are not (unless you voluntarily take a withdraw). Thus, delaying the RMD age could be the catalyst for avoiding Medicare surcharges for 1-3 years.

Let’s look at an example.

• Sue is 71 (born in the year 1951) and is in the lowest Medicare tax tier. She doesn’t pay any Medicare surcharges currently. Although she hasn’t paid any yet, her income is very close to the threshold of her being subject to IRMAA.
• If Sue fell under the old rules from the original SECURE ACT, her RMD at 72 would have triggered IRMAA.
• Notably, surcharges would have been faced when she was 74.
• Now, with the new legislation, Sue won’t have the RMD at 72 and will not face surcharges at 74. Furthermore, if her birth year was 1960, she would have three more years of avoiding the surcharges.

Now that we’ve gone through the positives, let’s highlight the negative of the RMD age change: larger required withdrawal amounts.

The Bad News

Larger Required Amounts

A key input in the calculation of an RMD is the life expectancy of the individual, which is determined by their age and the IRS’ published charts. The older the individual, the shorter the life expectancy and vice versa. The shorter the life expectancy, the larger the RMD. When the specified age was 70-1/2, the life expectancy was longer compared to when the law changed to 72, and now 73 or 75. Thus, the RMD in the first year was smaller compared to now. Now, account holders face a shorter life-expectancy table which then imposes large required amounts to withdraw. This is negative because RMDs are fully taxed at ordinary income rates. Larger RMDs generally equate to larger tax bills.

Let’s go back to Sue. Ignoring fluctuations in account balances year to year, Sue’s RMD at 70.5 was less than her RMD at age 72 which was less than her RMD at age 73 and 75. The younger Sue is, the lower her RMD (based on the life expectancy tables).

All these changes to the RMD rule within the last 5 years can be hard to follow. Fortunately, we stay on top of what you need to know and are here to advise you on the important details and decisions. Remember, it’s not what you make but what you keep that counts.