When it comes to retirement account distributions rules, nothing is easy. And, things just got more complicated. At the end of 2019, the budget bill had a surprise provision in it: The SECURE Act was tacked on at the end. It passed, lock, stock and barrel. Changes in the SECURE Act and required minimum distributions (RMD) were unexpected. For the next couple of years the new rules may confuse anyone who is age 70 or 71 or 72. And, the law may change your plans for retirement withdrawals.
We All Know Age 70 ½ Is Important
We Baby Boomers have been conditioned for decades that when we reach age 70 and a half, we must tap our IRAs. 70½ is when we must begin taking money out of our IRAs and inactive employer plans because Uncle Sam demands his share. It’s been easy to confuse age 70½ for RMDs with age 70—the age when you maximize your Social Security benefit. But, we’ve managed to muddle through these half-birthday ages and the quirky rules.
But now, as of December 31, 2019, the rules changed! Or did they? Well, some of the rules did change, but not for everyone. Confusing? Keep reading…
Do You Know Your Exact Birthday?
For some Boomers, the required minimum distribution (RMD) rules changed; for others, they didn’t. So for the next couple of years we’re going to have “old RMD rules” and “new RMD rules”. Let’s define each set of rules:
- Old RMD rules apply to you if you were born in the first half of 1949 or in years before 1949. Specifically, you had to be born on June 30, 1949 or earlier. That means you reached age 70 in 2019 or before. And, most importantly, you reached age 70½ in 2019 as well. As an example, if your birthday is June 3, 1949, you reached that crazy RMD age of 70½ on December 3, 2019.
- New RMD rules apply to you if your birthday isn’t mentioned above. In other words, if you were born on July 1, 1949 or after, you will now be playing by the new RMD rules. That’s because you will reach age 70½ in 2020. As an example, if your birthday is July 16, 1949, you would reach 70½ on January 16, 2020.
In one of the more complicated parts of the new SECURE Act and required minimum distributions, when you turn 70 ½ determines which set of rules applies to you.
72 is the new 70 ½
At the core, the SECURE Act changed the age when selected Boomers, and all the younger folks, are required to begin tapping IRAs. The new RMD age is 72. This allows many to slightly delay when they must start to draw down their tax-deferred retirement accounts. But during this transition period, switching from 70½ to 72, there is a healthy amount of added confusion.
That’s why knowing your exact birthday is so important. And, it’s more critical to those born in 1948, 1949 and 1950. For the rest of us, things are clearer. We are either already taking RMDs on a schedule, or we’ll wait until the year we turn 72.
In a nutshell, if you reach age 72 in 2022 or later, your new required minimum distribution has moved from age 70½ to age 72. This may change your plans for when to turn on your IRAs for income. You’ll want to take a fresh look at your overall retirement income plan to see what impact, if any, waiting until 72 makes on your income.
Of note: It’s just the Boomers born in 1949 who get split between the old rules and the new.
What If You Already Take RMDs?
If you are already required to take a minimum amount from your IRAs and former-employer plans, you must continue to meet that obligation. There is no skipping a year. Once you are formally in RMD mode, you must continue to take out the minimum calculated value based on the IRS’s formula. (More on that below).
That’s why knowing if you turned 70 ½ in 2019 is so important. If that is you, you fall under the old rules and must continue to pull money out each year going forward.
And, if you miss a year of taking the right amount of money from each account type, the IRS will come knocking at your door. You’ll owe a 50% penalty on the amount under the minimum that you did take out. For example, let’s say you had a $60,000 RMD. But, you thought you could skip a year with these new rules. You’ll owe $30,000 to the US Treasury next year. That’s in addition to your next year’s RMD.
The government is serious about getting their money. Your taxes have only been DEFERRED while you’ve been saving for retirement. Once you reach age 70½, or going forward, age 72, you need to pay those taxes. This is not a rule to misunderstand.
Which Accounts Have A Required Minimum Distribution?
Keep in mind that each type of tax-deferred account must be drawn down once you are in RMD land. In the retirement industry, we talk about the groups or buckets of accounts as those that are “like-registered.” Depending who sponsors the account and how beneficiaries can be named help define different registrations. Here are the most common buckets/groups and each one gets a separate distribution:
- IRAs are one group. This specifically includes Traditional IRAs (both tax-deductible and after-tax), SEP-IRAs, SIMPLE-IRAs, “Spousal” IRAs and Rollover IRAs.
- Company 401(k) plans are a group. Each employer plan requires a separate calculation and distribution. This includes Roth 401(k) accounts.
- 403(b)s are a third group and each must have a calculated RMD and distribution.
- 457(b)s are another group. They will be governmental plans or non-governmental plans. They are kept separate from other types of employer plans.
- Certain annuities are yet another type of retirement account that have an RMD requirement.
- And, you may have other types of tax-deferred accounts, such the old Keogh plans or SARSEP plans and such.
When we each get to RMD age, having all kinds of tax-deferred accounts all over the place can be quite challenging to manage. You, the owner of the accounts and the taxpayer, is 100% responsible for getting all of this right. It’s not for the faint of heart!
Calculating Your RMD
Lots of folks don’t care for all the steps to calculate their multiple RMDs. It’s often a very effective step to pull all these accounts together into one giant IRA. All of the money (except annuities) is portable, meaning you can move employer money to an IRA. In most cases today, you can also move all your money to one employer plan. But, make sure to talk to your benefits person or read your documents to see which specific “registrations” they will accept.
In general, the calculation is quite simple. You use your balance reported by the financial company as of December 31 of last year and divide by a specific factor. If you owe an RMD for 2020 on an IRA that you own, the equation is:
12/31/2019 IRA Balance / Uniform Lifetime Table Factor = RMD
A Typical Household with Retirement Accounts
Let’s set up a typical household for a married couple and look at their tax-deferred accounts. These are their balances at year end. Each account will have a separate RMD:
| Sally Snowflake (age 72) | Richard Raine (age 75) | |
|---|---|---|
| Traditional IRA at Vanguard | $50,000 | $33,000 |
| Rollover IRA at Fidelity | $200,000 | $350,000 |
| SEP IRA at local bank | $8,000 | N/A |
| 401(k) | N/A | $95,000 |
| 403(b) | $83,000 | N/A |
| TOTAL | $341,000 | $478,000 |
In this case, using the December 31st balances, each person has four tax-deferred accounts and will need to calculate their own RMDs.
Most households don’t create their retirement income from individual buckets. Instead, they would consider their grand total available for retirement income is $819,000. But from an RMD perspective, the total is a meaningless number. RMDs must always be calculated at the account level, and each person has their own accounts. So, Sally and Richard must each figure out the RMD from their accounts and withdraw the appropriate amount of money from each group.
Let’s Look at their Situation in More Detail
Sally and Richard are different ages, which means the lifetime factors they will use to calculate their RMDs will be different. Sally’s “life expectancy” factor is 25.6. This means she must withdraw 3.9% of each account value. Richard’s “life expectancy” factor is 22.9, so he must withdraw 4.4% of each account value.
These are Sally and Richard’s required amounts they must take from each account group:
| Sally Snowflake (age 72) | Richard Raine (age 75) | |
|---|---|---|
| Traditional IRA at Vanguard | $1,953 | $1,441 |
| Rollover IRA at Fidelity | $7,813 | $15,284 |
| SEP IRA at local bank | $313 | N/A |
| TOTAL IRA GROUP RMD | $10,078 | $16,725 |
| 401(k)s | N/A | $4,148 |
| 403(b) | $3,242 | N/A |
They each must pull money out of their IRAs and their employer plans. But, there is something interesting about their IRAs. You see that Sally has money in three different institutions. Since all IRAs form a group, she has a choice to make: Take the RMD amount from each financial company, or take the full calculated value from just one account. Sally can even take $8,000 from her local bank, since it’s a small account and she wants to make things easier in the future. And, she’d take the remaining $2,078 from either Fidelity or Vanguard. It’s her choice.
The bottom line is that you must fully distribute the calculated value for each group from that group. But, you do not have to take it from each financial company.
Richard and Sally also must take their RMDs from their respective employer plans.
This Is All Too Complicated! How Can I Make It Easier?
Yes, it is complicated! Yes, the Secure Act made Required Minimum Distributions more complicated this year. And, keep in mind that you don’t just calculate your RMD the year you are 70 ½ or 72. You must calculate a new RMD every year that you are alive and have money in a tax-deferred account. Imagine dealing with these multiple accounts at 85, 90, or 95. It doesn’t get any less difficult!
To make it a little easier, if Richard and Sally each choose a financial company to put their money, and keep it all in one registration (just the IRA or just the 401(k)), life would be a lot simpler every year.
Here’s what their household now looks like after moving money to one place and one account:
| Sally Snowflake (age 72) | Richard Raine (age 75) | |
|---|---|---|
| 1 IRA at 1 Financial Company | $341,000 | $478,000 |
| RMD | $13,320 | $20,873 |
Most financial services companies will also help you calculate your RMD, but they can only do so for the accounts they hold. And, you can set up automatic distributions monthly, quarterly, or once a year. Your money will be sent to your regular bank account outside of the investment company, or to a regular brokerage account at the financial institution.
You are in the driver’s seat when it comes to RMDs. But, I can tell you from working in this industry for almost 30 years, the more you can streamline this stuff the better. Missing even a partial RMD causes a lot of headaches and money out of your wallet.
Final Thoughts
The SECURE Act and required minimum distributions changes are a lot of hoopla about nothing. But the confusion is real. Moving RMDs by effectively one year and causing all this ruckus may not be worth the effort during the transition period. The original proposal was to move RMDs out to age 75. But, that must have been too big a revenue hit at the Treasury.
It’s interesting that the IRS noted that only 20% of all IRA owners wait until RMD age before drawing money out of their accounts. No wonder. Most people actually save in retirement accounts to use that money – in retirement!
And, there is more to come, perhaps as soon as later this year. The Life Expectancy tables are going to be updated to reflect that we’re living longer. There hasn’t been a big change since the “uniform” table that we use now was introduced in 2002. The net effect is that the factors for how much you’ll have to take out will change slightly. Stay tuned for more on that later.
Regardless of law changes and revenue need in The Treasury, what’s most important for each of us is to know the process and deadlines for meeting RMD. Each and every year once you reach your magic age of 72. Unless it’s 70½. You don’t want to get hit with a severe penalty.
Some Good Resources for Learning More about the Secure Act and Required Minimum Distributions
The IRS is the place to go to get the facts about RMDs. They have resources and steps that help you see the steps.
There is a detailed discussion of how RMDs work from a tax perspective. It is a good overview.
For access to the IRS section that explains all the ins and outs of taxation on retirement accounts, Publication 590-B is your resource.
And, don’t forget to check the various financial institutions where you have your IRAs. They may have educational information and calculators or worksheets to help you with your RMDs.
