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Secure Act 2.0 & RMDs


The Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 is a piece of legislation designed to enhance the retirement savings landscape in the United States. This article examines the implications of this act on required minimum distributions (RMDs) and explores additional strategies made available through this new legislation.


Introduction:

The SECURE Act 2.0 is a bipartisan bill aimed at further improving the retirement savings landscape in the United States. The initial SECURE Act, enacted in 2019, implemented various provisions to promote retirement savings and increase the flexibility of retirement plans. Notably, the SECURE Act altered the starting age for non-inherited RMDs from 70.5 to 72 years old. Concurrently, significant adjustments were made to Inherited IRAs, shortening the distribution schedule for many non-spousal inheritors. These changes may reduce taxation during the original owner's lifetime but potentially increase taxation for non-spouse inheritors of those accounts.


The SECURE Act 2.0 expands on many of the original act's provisions. In this article, we will focus on the new legislation's updates to RMDs, which dictate the minimum amount individuals must withdraw from their tax-deferred retirement accounts annually. Below, we will discuss the impact of the SECURE Act 2.0 on RMDs, including changes to the starting age and the removal of RMDs for specific accounts.


Section 1: Overview of Required Minimum Distributions

RMDs are compulsory withdrawals from tax-deferred retirement accounts, such as traditional IRAs, 401(k)s, and 403(b)s. Tax law mandates RMDs to ensure that the tax advantages of these accounts are limited. These tax-deferred dollars were not subject to income tax when initially earned. However, Congress intended for deferred taxation to occur later, usually during retirement. RMDs are typically subject to income tax at the individual's ordinary income tax rate.


The RMD rules apply to:

  • Non-Roth IRA owners

  • Individual Retirement Annuities

  • Retired owners of workplace retirement plans, including 401(k)s, 403(b)s, and 457(b)s

  • Owners of inherited IRAs (Roth and Traditional) and other inherited retirement accounts

The RMD amount depends on the account balance and the individual's age, with the IRS providing life expectancy tables to calculate the RMD. The distribution period decreases as the individual grows older, resulting in a larger RMD percentage.


RMDs for those who inherit an account follow a different set of mandatory distribution rules. The original SECURE Act reduced the timeframe for many inherited IRAs to be fully distributed, potentially increasing overall tax liability and reducing deferred growth. Many inherited accounts are now subject to a 10-Year rule, shortening the timeframe for many inheritors to distribute the funds. These changes particularly affected those approaching higher marginal rates but did not retroactively apply to previously existing inherited IRAs.


Section 2: The SECURE Act 2.0 and Changes to RMDs

The SECURE Act 2.0 introduces significant changes to RMDs, including:

  • Increased RMD Starting Age: The new legislation increases the RMD starting age from 72 to 73 and 75 years (depending on the owner's year of birth) for non-inherited accounts that are subjected to RMDs. This change allows individuals additional time to accumulate wealth in their retirement accounts before mandatory withdrawals begin.

​Date of Birth

New RMD Starting Age

Between 1/1/1951 and 12/31/1957

​73

Born on or after 1/1/1958

75

  • RMD Penalty Reduction: The penalties for not taking an RMD on time have been reduced. Previously, the penalties were 50% of the RMD not taken. This amount has now been reduced to 25% and further reduced to 10% for those who correct the error in a timely manner.

  • Employer Roth RMD Exclusions: Roth accounts that are part of an employer plan are now exempt from Required Minimum Distributions. This change aligns these accounts more closely with non-employer Roth IRAs, which are not subject to Required Minimum Distributions.

Section 3: Implications of the SECURE Act 2.0 on Retirement Strategies and Tax Planning

The changes to RMDs introduced by the SECURE Act 2.0 have several implications on retirement planning, tax strategies, and estate considerations:

  1. Delayed Tax Payments: The increased RMD starting age allows individuals to defer taxation on their retirement savings for a more extended period, potentially reducing taxation over the account holder's lifetime.

  2. Roth Conversions: For clients considering a Roth Conversion, a delay in Required Minimum Distributions enhances the conversion opportunity in the new years that would have otherwise been subjected to Required Minimum Distributions. Generally, RMDs must be taken before a Roth Conversion. The additional years without RMDs have the potential to reduce taxation over the account owner's lifetime and for future heirs.

  3. IRA Voluntary Distributions: In some cases, individuals may need to access funds from their IRAs before the RMDs begin or may wish to do so voluntarily while in a lower tax bracket. These earlier distributions from an IRA may result in a reduced tax liability over an individual's lifetime, depending on their current and future marginal tax rates. If Required Minimum Distributions push account owners into a higher marginal bracket, it may make sense to begin withdrawals or make Roth conversions while in a lower bracket.

  4. Additional Estate Considerations: By reducing the overall mandated distributions during the account owner's lifetime, it increases the likelihood that these funds will be inherited. These inherited funds pose a potential increased tax liability for the heirs. Other account types could potentially be a more tax-efficient way of transferring wealth.

  5. Enhancing Employer-Based Roth Accounts: For many workers, Roth employer plans were already the ideal solution for their retirement savings. The removal of Required Minimum Distributions on these accounts further enhances their desirability as it allows these funds to continue growing tax-free for longer periods.

  6. Impact on Charitable Giving: The SECURE Act 2.0 allows for qualified charitable distributions (QCDs) to be made from IRAs starting at age 70½, even though the RMD starting age has been increased to 75. This change creates an opportunity for tax-efficient charitable giving strategies, as QCDs can be used to fulfill philanthropic goals without incurring income tax liability.


Section 4: Example of Secure Act 2.0 impact on Jane Doe

Jane Doe recently retired and will turn 63 later this year. Throughout her career, she primarily saved in her previous employer's traditional 401(k) retirement plan. She has two grown children who are both gainfully employed, and she plans to name them as beneficiaries on her account. Since she was born after January 1, 1958, her new required minimum distribution (RMD) age has moved from 72 to 75 years.


Depending on the size of Jane's tax-deferred retirement accounts and her retirement spending, it is possible that her RMDs (starting at age 75) will exceed the amount needed to fund her lifestyle in retirement. These excess distributions generated by her RMDs will likely subject her to additional taxation after age 75 and could even push her into a higher marginal bracket. Given that Jane is only 63, she may want to consider converting a portion of these tax-deferred dollars to Roth dollars.


The Secure Act 2.0 now allows Jane to continue converting through age 74 without having to take an RMD out of her accounts prior to the conversion. This could result in a reduction in taxes over her lifetime, depending on her current and future marginal tax rates. Moreover, the newly converted Roth funds could potentially be inherited more efficiently. If Jane converts those dollars in a lower bracket than her heirs, the after-tax purchasing power should be greater for her heirs than if they had inherited only tax-deferred assets.


If Jane had not converted, it is possible that the Secure Act 2.0 would have increased her tax liability or the tax liability for her heirs. Jane's assets would have three more years of tax deferral, which could have resulted in higher distributions after she turned 75. These excess distributions may have pushed her into a higher bracket, increasing her lifetime tax liability. Her children would also inherit more tax-deferred dollars, which would be subject to their higher marginal tax rates. Without the Secure Act 2.0, these excess dollars may have been directed into a taxable investment account that would receive a step-up in basis for the inheritors. Those dollars would likely be preferrable to the two children in this scenario.


In summary, the Secure Act 2.0 has provided an increased Roth conversion window, which could reduce taxation during Jane's lifetime and taxes owed by her heirs.


Conclusion:

The SECURE Act 2.0 introduces significant changes to RMDs which are expected to impact retirement savings, tax planning, and estate planning strategies. As the SECURE Act 2.0 comes into effect, it is crucial for individuals and financial advisors to stay informed about the evolving retirement landscape and adjust their strategies accordingly.




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