Change in RMD Formula is Good News for Retirees
In 2018, then President Trump directed the IRS via executive order to study the life expectancy tables that are used to determine required minimum distributions, or RMDs, of tax-advantaged retirement plans. The goal of the order was to see if the tables should be updated to reflect improvements in longevity since the last table update in 2002.
The IRS complied and the result is good news for retirees. The IRS did indeed update its actuarial tables for the first time in two decades, effective January 1, 2022, reflecting improvements in mortality rates. The new tables, based on longer projected lifespans, mean lower RMDs, thus allowing retirees to keep a bit more money in their tax-deferred retirement accounts than under the old tables.
A little background on RMDs and how they are determined might be in order. So called tax-favored retirement plan vehicles allow account owners to defer paying taxes on the account contributions, earnings and growth until the funds are withdrawn. Because more money remains invested, this allows it to grow at an accelerated rate versus an account where money has to be diverted to pay taxes.
Naturally, most would prefer to never pay taxes on the funds, so unless the money is needed to pay living expenses, the tendency would be to leave the money in these accounts indefinitely and avoid the tax liability completely. Therein lies the problem from a government revenue standpoint. According to the website, www.statista.com, at the end of 2021, there was over $39 trillion in value lying untaxed in such accounts. Yes, I said, $39 trillion, the potential tax revenue on which would be trillions and trillions of dollars.
Allowing those funds to remain permanently untaxed would result in a staggering loss of revenue to the government. To prevent this from happening, the tax code requires you to withdraw a specific minimum amount (the RMD amount) each year once you reach a certain age (currently age 72), and that amount is based on your life expectancy.
RMDs apply to traditional IRAs, SEP IRAs, SIMPLE IRAs, profit-sharing and defined benefit plans, as well as 401(k), 403(b) and 457(b) plans. The increasingly popular Roth IRAs, however, are NOT subject to the RMD rules.
The calculation of RMDs is relatively straight forward and simple. First, you determine the value of your retirement account as of the previous December 31st. Then, you divide that value by the distribution period number shown in the IRS Uniform Lifetime Table that corresponds with your age. The result is your RMD amount.
It's important to note that in the year you reach age 72, your RMD beginning age, you have until April 1 of the following year to actually take your first RMD. However, your 2nd RMD will have to be taken on or before the end of that same year if you delay the 1st RMD until that April deadline, meaning you will be taxed on two RMDs in one year, so be aware of that when planning RMD #1. After that, the RMDs must be taken each year by the end of the year to avoid substantial penalties.
As an example, a 72-year-old has a distribution period figure of 27.4 under the new tables. If she has $1,000,000 saved up in her IRA, her initial RMD will be $36,496. Under the previous table, the balance would have had to be divided by 25.6, making her first RMD $39,063.
Of course, you can always withdraw more than your RMD if you so choose. But these new tables give retirees a bit more flexibility to keep more of their money invested and working for them and their families long-term.
