The SECURE 2.0 Act of 2022 makes it easier to accumulate retirement savings at every stage of the financial journey. But the Act also took steps to potentially enhance retirement savings for those close to or in retirement. Required minimum distributions (RMDs) can be burdensome from both an income and a tax planning perspective. The Act creates some breathing room by extending the age at which RMDs kick in and builds in some opportunities to prepare a multi-year plan to maximize income and minimize taxes.
Currently, retirement savings that were contributed to tax-deferred accounts, such as 401(k)s and IRAs, must be withdrawn beginning at age 72. The goal of RMDs is to ensure that taxes are paid on the funds. The amounts are determined by a formula that includes the account balance at the end of the previous year and a life expectancy factor published by the IRS. This can result in the RMD increasing over time.
- Removing increasingly larger amounts from savings can lower overall growth, particularly in down markets
- Withdrawing funds for RMDs can reduce portfolio diversification
- RMDs can create higher income, which can bump you into a higher tax bracket
Changes to RMDs in the SECURE 2.0 Act
The SECURE 2.0 Act raises the age at which RMDs begin to 75, but it does so in a two-stage process. The first stage gives retirees nearing age 72 a window to take advantage of lower asset values. For those in early retirement, the second stage expands the time to undertake financial and tax planning strategies.
Beginning in 2023, the age for RMDs is 73. Using the extra year to convert to a Roth account while market values are lower means that the tax liability will be smaller, and more funds can be converted. This will lower the value of the tax-deferred account, minimizing subsequent RMDs and creating more control over income – and tax brackets. The amounts converted to a Roth account will grow tax-free and will not be subject to RMDs.
Beginning in 2033, the age for RMDs jumps to 75. For those in early retirement, the extra years before RMDs kick in can offer additional opportunities to optimize income and taxes throughout retirement. Having additional time can allow for:
- Delaying social security to maximize benefits. Living expenses can be withdrawn from the tax-deferred accounts
- A more gradual Roth conversion timeline that allows for tax planning
- Time for strategic planning of taxable income events, such as asset sales
What Happens if You Don’t Take a Required Distribution?
The current penalty for failing to take distribution is 50% of the amount shortfall amount. The SECURE 2.0 Act changes this to 25%, and if you take the full amount by the end of the second year after it was due, the penalty is reduced to 10%.
The Bottom Line
The tax benefits of saving into tax-deferred accounts become a tax liability when the savings amassed have to be withdrawn in retirement. The sweet spot for a Roth conversion is before RMDs kick in, and having a few more years to enact thoughtful strategies can mean more flexibility around both income and taxes.
While the greatest benefit is for people who have several years before reaching age 73, having an extra year when asset values have declined provides an opportunity to convert funds to a tax-free account and lower the value of tax-deferred 401(k)s and IRAs subject to RMDs.