Congress Raises the Required Minimum Distribution Age for Retirement Accounts

Congress recently raised the age that you have to take distributions from your tax-deferred retirement accounts, such a 401k or Individual Retirement Account (IRA). These changes also allow for more tax-deferred growth and possible Roth conversions before the required distributions begin.

What is a Required Minimum Distribution?

Under the Secure Act (Setting Every Community Up for Retirement Enhancement Act), persons born between 1951 and 1959 must begin to take distribution from their retirement accounts at age 73 rather than the current age of 72. For persons born in 1960 or later, the RMD age is 75.

The first year’s distribution for those age 73 is approximately 3.8 percent of the previous year’s December 31st balance. The required distribution percentage increases each year. By age 80, the percentage is 5% and by age 85, it is 6.3%.

Congress wants to tax the money so that it does not grow tax free forever. The distribution, however, does not have to be spent. You just have to move it out of the retirement plan and into a taxable account. The distribution is included in your taxable income for the year.

Larger Balances Despite Required Distributions

Most employees make pre-tax contributions to their 401k because they believe they will be in a lower tax bracket once they retire. The idea is to pay a lower tax rate later. But the rise in the stock market over the last 10 years has, notwithstanding the dismal 2022 returns, made many tax-deferred accounts quite large.

For example, a 3.8% withdrawal on $2 million account will be $76,000. Add that money to Social Security, dividend and pension income means you may be in a higher tax bracket in retirement than you had anticipated. In addition, your Medicare premium may be higher if your adjusted gross income is greater than $97,000 for a single filer or above $194,000 for married couples (2023 rates).

History has shown that, over time, the stock market returns at least six percent over any 20-year period. The account will continue to grow, despite the withdrawals, because the RMD percentage is lower than long-term returns. Thus, the balance only gets bigger meaning even larger required distributions in the future.

Roth Conversion Strategy

One strategy to lower your taxes in the future is to convert a portion of the account to Roth status before RMDs begin. The benefit of a Roth IRA is that you do not have to take distributions and the money grows tax-free.

Most folks make the conversion later in the year. They project their income for the year and then convert enough of their account to stay in the lower tax bracket or avoid the Medicare surcharge. For example, the 2023 22% bracket for singles is between taxable income of $44,726 and $95,376. If your projected taxable income is $60,000, then you have a potential $35,376 Roth conversion to stay in the 22% tax bracket. The $35,376 will be included in your taxable income for the year.

It is best to pay the income tax due out of taxable assets rather than out of the converted amount. By doing so, the larger amount grows tax free.

In sum, delaying the start of required distribution provides an opportunity to move more assets to Roth status. In a Roth IRA, the assets continue to grow tax free and are not subject to required minimum distributions.

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