If you’ve been reading up on tax-advantaged retirement accounts such as IRAs and 401(k)s, you’ve probably heard the term “required minimum distribution” tossed around on more than one occasion. Required minimum distributions, or RMDs, are annual withdrawals that must be taken when you house your retirement savings in a traditional IRA or any type of 401(k). But thanks to an executive order from President Trump at the end of August, the rules surrounding RMDs may come to change.
Currently, you’re on the hook for RMDs starting at age 70 1/2. Specifically, you must take your first RMD by April 1 following the year in which you turn 70 1/2. All subsequent RMDs must then be taken by the end of their respective calendar years. President Trump’s order, however, seeks to possibly push back the age at which RMDs first come into play, thereby buying retirees far more flexibility.
Why the change? Primarily, it boils down to the fact that Americans are living longer, and therefore should be given a more generous period of time during which to grow their savings. Pushing back the age at which RMDs kick in would be a huge benefit to millions of seniors, which is why it pays to keep our fingers crossed and hope this change is implemented.
The problem with RMDs
RMDs don’t affect all retirees. After all, there are some seniors who retire in their 60s and begin taking substantial withdrawals from savings the moment they leave the workforce. But if you’re in the position of not needing the money from your nest egg come 70 1/2, RMDs can be a huge burden for a number of reasons.
First, RMDs create an automatic tax situation if your savings are housed in a non-Roth account. If you’re forced to take RMDs from a traditional IRA or 401(k), you’ll lose a portion of your withdrawals to taxes. Furthermore, having that additional income could bump you into a higher tax bracket, or create a situation where you’re forced to pay taxes on your Social Security benefits.
Worse yet, if you miscalculate your RMD, or fail to take any portion of it, you’ll be hit with a 50% penalty on whatever amount you neglect to remove, whether intentionally or not. Your RMD will vary from year to year and will be a function of your account balance coupled with your life expectancy based on IRS tables. In other words, the calculation is complicated, and if you botch it, you risk losing even more of your hard-earned savings.
But tax implications aside, RMDs limit the extent to which seniors can continue to accumulate wealth. Any time you remove funds from a retirement plan, you lose out on the ability to grow that money in a tax-advantaged fashion. Sure, you can always stick your RMD in a traditional brokerage account if you don’t need the money and invest it that way, but you’ll pay taxes on any associated gains, whereas you wouldn’t do so in an IRA or 401(k).
Pushing back the age at which RMDs kick in, therefore, addresses all of these problems. It gives seniors a lengthier period of tax-deferred growth and allows them the option to avoid taxes on their savings for longer. Of course, whether or not the rules surrounding RMDs will actually change is yet to be determined. For now, if you’re concerned about RMDs, house your savings in a Roth IRA. It’s the only tax-advantaged account out there that doesn’t impose mandatory distributions, and it offers a host of additional benefits that make it a worthwhile option to consider.