The U.S. Senate is considering tax legislation that would provide the opportunity for your retirement savings to grow tax-deferred for a longer period of time before required minimum distribution (RMD) rules set in.
Under current law, once you turn 70½, you are required to take RMDs from your qualified retirement plans (401(k), traditional IRA, and other tax-deferred plans) or face a 50% penalty on the amount that should have been withdrawn. The amount of your RMDs is based on your life expectancy and varies depending on your account balance and your age. Because withdrawals from qualified retirement accounts are subject to ordinary state and federal income tax, RMDs can push investors into a higher tax bracket, something retirees should consider when planning their retirement income strategy.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which includes 29 provisions, is aimed at preventing older Americans from outliving their assets. It would change the RMD rules by allowing investors with retirement accounts an additional 18 months, or until age 72, before requiring minimum distributions.
Whether or not the SECURE Act of 2019 is signed into law, here are some planning ideas that may reduce your tax liability when planning your withdrawal distribution strategy:
- Make a Qualified Charitable Distribution (QCD) – A QCD is a direct transfer of funds from your IRA custodian which is payable to a qualified charity. QCDs are tax-deductible and can help mitigate your tax bill. While many IRAs are eligible for QDCs, there are some eligibility requirements: you must be 70 ½ or older, they are limited to the amount that would otherwise be taxed as ordinary income, the annual maximum amount is $100,000, and your RMD amount must be withdrawn by your RMD deadline.
- Convert to a Roth account – A Roth conversion offers several advantages. Once you turn age 59 ½ and have owned your Roth retirement account for at least five years, you can withdraw your contributions and any earnings free of federal (and most state) income taxes. Therefore, if you anticipate being in a higher tax bracket after retirement, you may want to consider converting a portion of your traditional IRA and/or 401(k) into a Roth account. However, keep in mind that you must pay ordinary income taxes at your current rate on funds when you convert them, so you will want to be mindful that the tax impact could push you into a higher bracket in the year of the conversion.
- Start distributions prior to the date at which RMDs are required – It may make sense to start withdrawals before required minimum distributions are required, especially if you are in a lower tax bracket when you retire. This allows you to space them out more, reducing the tax hit.
- Keep working – As baby boomers reach retirement, many of them continue working past age 70. As long as you work throughout the year, you are not required to take RMDs from your current employer’s 401(k) (unless you own more than 5% of the company), even if you are beyond 70 ½ years old. You will still have to take RMDs, however, from 401(k)s from past employers, IRAs, or other qualified plans.
While it’s hard to predict which bills get signed into law, especially given the current political climate, the SECURE Act did pass the House with bipartisan support. The Arnerich Massena Wealth Management team will continue to follow these developments and will keep our clients apprised of any changes or new rules. Please contact us if you have questions about how this legislation may affect your planning.