Secure 2.0 allows retirees to defer RMDs. That doesn’t mean they should.
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It’s worth doing the math to find out if taking RMDs earlier could ease your tax bill.
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The Safe 2.0 Act gives savers aged 72 and under an extra year before you have to withdraw money from your pension accounts. But just because you can delay your required minimum distribution (RMD) doesn’t mean you necessarily should, financial advisors say.
Passed late last year, the Comprehensive Pension Act raised the RMD age to 73 in 2023, up from 72. Starting in 2033, the RMD age will increase to 75.
The changes most immediately affect those turning 72 this year, who otherwise would have been required to take RMDs by April 1, 2024. (The Internal Revenue Service gives first-time adopters a deadline of next spring; in all subsequent years, RMDs must taken by the end of the year.) Your RMD is calculated by dividing your retirement account balance as of December 31 of the previous year by what the IRS calls your “life expectancy factor.” The resulting amount is considered income; you have to withdraw it from your account and you will owe tax on it. RMD rules apply to traditional IRAs as well as employer-sponsored retirement plans such as 401(k)s and 403(b)s.
Most Americans do not have the luxury of waiting, as they need withdrawals from their retirement accounts to live on. But among those who can afford to wait, delaying is not always the best move. If you delay your RMD and your retirement account grows, you’ll have to withdraw a larger amount next year. (Even if your account balance stays flat, you’ll need to withdraw more since your life expectancy factor will be lower.) That extra income can increase not only the amount you pay in income taxes, but also your Medicare premiums. .
“Some of the old rules of thumb, like you should let your tax-deferred accounts marinate as long as possible, don’t always apply,” said Josh Strange, a certified financial planner and president of Good Life Financial Advisors at NOVA in Alexandria, Va.
Without a crystal ball showing how the markets will perform this year, it’s impossible to say whether current 72-year-olds might benefit from delaying their RMDs for a year, all other factors being equal. (Market participants polled by Barron’s expected the S&P 500 to end the year higher than today’s levels). But what if all other factors are not equal? Say you’re 72, expect to retire this year, and be in a lower tax bracket next year. In that case, it probably makes sense to defer the RMD until 2024. On the flip side, if you plan to sell your primary home next year and realize more than $250,000 in capital gains (or $500,000 if you’re married filing jointly), it may be wise to start your RMDs this year to avoid a possibly larger RMD being added to next year’s income along with your capital gains. That could trigger higher Medicare premiums for you down the line.
Rather than waiting until you’re on the brink of RMDs to do tax planning, you’ll have a better chance of dealing with the tax consequences if you start years in advance. “The sooner the better,” said Kris Yamano, a partner at Crewe Advisors in Scottsdale, Arizona. A popular move is to do a Roth conversion after you retire but before you reach RMD age. You’ll likely be in a lower tax bracket during that time, so converting your traditional IRA to a Roth IRA—either all at once or staggered over a few years—will mean you’ll owe less in taxes on the converted amount than if you did it when you were in a higher bracket.
It can also be beneficial to withdraw from your retirement accounts earlier than you had planned. If, for example, taking withdrawals earlier would allow you to delay claiming Social Security until age 70 to receive the full benefit, that might be worth considering. Laurence Kotlikoff, a Boston University economics professor who sells Social Security software, ran a scenario with a hypothetical high-earning couple in their early 60s who planned to retire and claim Social Security at age 64. The couple lived in New York and planned to wait until 75 to take their RMDs. Using his software MaxiFi, he found that waiting until 75 would be less tax efficient for this couple than starting regular withdrawals at age 64, since the reduction in New York state taxes and Medicare premiums would exceed the increase in federal taxes they owed from previous withdrawals.
“This is a very complex calculation,” Kotlikoff said. “It’s very individual.”
Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com
