How Retirement Account RMDs are Changing

You’ve worked hard, saved for retirement, and planned responsibly. Now your earning years are over, and you are free to spend your time socializing, volunteering, traveling, or however else you please. Also, you can finally start spending some of that money you’ve carefully invested over the past decades!

In fact, depending on your age, you may have to start withdrawing from these accounts. Tax advantages encourage many people to start saving for retirement. However, to avoid a scenario in which an account keeps accumulating wealth indefinitely—beyond the goal of incentivizing saving behavior—the IRS has mandated “required minimum distributions” (RMDs).

Calculating and planning around RMDs can be complex, with many variables and exceptions. To complicate matters further, some of the rules changed with the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) of 2019. To help you understand if and how the changes could affect your overall financial plan, this article explains some of the basic concepts and more significant revisions.

Get ahead of the required beginning date

The SECURE Act has delayed the age at which taxpayers typically need to start taking deductions by a year and a half. If you were born after June 30, 1949, you now have a required beginning date of April 1 of the year following the year you turn 72. However, you should probably take that first RMD before the required beginning date to avoid taking two RMDs within one tax year, because in the years after, you’ll need to take RMDs by December 31.

The required beginning date has a notable exception: If you are still employed, you can defer taking RMDs from your current company plan until after you retire (assuming you have less than a 5% ownership interest in the company). Nevertheless, RMDs from your other accounts, including retirement plans from previous employers, must begin at the usual date.

Live long and use new tables

For most taxpayers, RMD calculations divide the prior year-end balance of each account by an age factor. IRS Publication 590-B for 2021 lists these factors, under the “Distribution Period” heading in the Uniform Lifetime Table (page 65). They’re a bit different than the ones you may have seen in the past because the IRS updated them based on new Life Expectancy tables, which were revised in 2020 but will go into effect for the first time this year. This example illustrates how the process for calculating RMDs with age factors remains the same:

Last year, 2021, Sally turned 74, so her factor based on the old table was 23.8. Her account balance was $100,000 at the end of the year prior, 12/31/2020, so she took her RMD of $4,201.68 ($100,000/23.8) by the end of last year.

This year, 2022, Sally turns 75, so her factor based on the new table is 24.6. For the sake of simplicity, let’s say her account balance was again $100,000 on 12/31/2021. Therefore, her RMD for 2022, which she must take before the end of this year, is $4,065.04 ($100,000/24.6).

Beneficiaries may need to keep stretching

Historically, most taxpayers who inherited retirement accounts could stretch the distributions over their lifetime. Before this year, their RMD calculation used the Single Life Expectancy table (page 48) for the first year and then subtracted one from the factor each subsequent year. The SECURE Act’s new “10-year rule” requires full liquidation of inherited accounts by the end of the tenth year after the deceased owner’s year of death.

Most tax and financial advisors took this change to mean that no distributions were necessary until the tenth year, and the beneficiary could take as much or little as they wanted for each of those nine years, provided the account was liquidated in the tenth year. However, the IRS recently released proposed regulations indicating that some beneficiaries must do both: Take annual RMDs according to the old stretch rules over the nine years and liquidate accounts in the tenth year. Depending on the final regulation, which should be released later in 2022, it may still be worthwhile to understand how the old stretch-rule works, so here’s an example:

In 2021, George turned 50 and inherited an IRA from his father, who had passed away that year at age 80.

Under the stretch rules, George must take RMDs beginning in 2022, at age 51 using the starting age factor of 35.3 on the Single Life Expectancy table. The account balance at the end of 2021 was $100,000, so George will take a distribution of $2,832.87 ($100,000/35.3) before the end of this year, 2022.

For next year, 2023, the calculation subtracts one (-1) from the starting age factor. Again, for simplicity, let’s assume the account has a balance of $100,000 on 12/31/2022, so his RMD for 2023 will be $2,915.46 [$100,000/(35.3-1)].

Under the old rules, this methodology would continue for 36 years. If the proposed regulation becomes final, George must take these annual distributions and liquidate any remaining balance by 2031. However, if George’s father had been younger and passed before he reached the age for his required beginning date, then George wouldn’t have to take annual distributions; he’d only need to fully liquidate the account in year 10.

The IRS gives legacy accounts a factor reset

Beneficiaries of retirement account holders who passed before 2020 had starting age factors based on the old Single Life Expectancy tables. To not leave them at a disadvantage, the IRS life allows a one-time factor reset for all “legacy” inherited retirement accounts. Here’s an example:

Bob, the original owner of an IRA, passed away in 2018 and Lilly inherited the account. She turned 50 in 2019 and the Single Life Expectancy table at that time gave her starting age factor of 34.2. Under the stretch rules, the RMD calculation subtracts one (-1) each year, so her factor was 33.2 for 2020 and 32.2 for 2021.

The new Single Life Expectancy tables go into effect this year, so her factor for 2022 is 33.2 instead of 31.2 (32.2-1). The current calculation (36.2-3) resets her starting age factor to what it would have been in 2019 under the new table. The reset doesn’t retroactively adjust previously taken RMDs, but it does apply to calculations going forward. Since the account was inherited prior to 2020, Lilly will continue to stretch the distributions over her lifetime using the adjusted age factor minus 1.

Perhaps it feels difficult to shift gears. When you’ve been working hard all your life, relaxing might not come easily. The tax code doesn’t make you actually spend your RMDs on fun stuff like plane tickets, excellent meals, and graduation gifts. Nor were the rules meant to absolve guilt about dipping into our savings. But if that unintended consequence works for you, go with it.

Luckily, you won’t need to spend your golden years sweating over how RMDs work, because your financial advisor and account custodians can help you with those calculations—but understanding the general concepts will enhance conversations with your advisor about RMDs. The rules for when and how much to take from your retirement plans are extremely intricate, and each individual retiree or beneficiary may face their own unique set of variables. If you recently turned 72, are approaching age 72, or have recently inherited a retirement account as a beneficiary, it’s especially important to schedule a review of your financial plan before the end of the year.