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Higher Life Expectancy, Lower IRA Required Distributions

If you are over 72 and own an IRA, 401(k), 403(b), or TSP, you may be on the receiving end of a gift from the President. In 2018 he issued an Executive Order on “Strengthening Retirement Security in America.” One of the provisions of that order may result in the IRS agreeing to reduce the required minimum distribution that Americans over age 72 that must withdraw from their retirement plan and pay ordinary income taxes on.

The Executive Order required the Secretary of the Treasury to determine if the life expectancy tables should be adjusted. It took the Secretary 15 months to conclude that they should.

This makes sense when we consider that Americans are living longer. According to Jeffrey Levine in a November 13, 2019, article at Kitces.com, “IRS Proposes New RMD Life Expectancy Tables To Begin in 2021,” life expectancy has increased for someone born in 2002 from 77 years to 78.6 years, a 2% increase. The life expectancy of someone 65 years old in 2002 increased from another 17.9 years to 19.4 years, an 8.4% increase. Yet the current life expectancy tables issued in April 2002 have not been adjusted.

The net effect of lowering the required minimum distribution is twofold. First, it will leave more in the retirement plan to accumulate. Second, smaller withdrawals will reduce the retirees’ federal and state income taxes.

This is only true, however, if the retiree does not need to withdraw more than the required RMD for living expenses. According to the IRS, 79.5% of all retirees withdraw more than the RMD, so arguably this new provision will only benefit the 20.5% who don’t need to withdraw more than the RMD for living expenses.

So what does this mean in dollars and cents? Let’s assume you just turned 72. You would divide the ending balance of your retirement account as of December 31, 2019, by 25.6, which equates to having to withdraw 3.91% from your retirement account. Under the proposed rules you would divide the year-end balance by 27.3, for a distribution of 3.67%, a reduction of 6.1%. If we assume you had $1 million in a retirement account, this would mean your RMD would be $2,432 less. If you were in a 22% tax bracket the savings is $535. If you are in a 37% bracket it is $900.

The savings grows as you get older. At age 84 your RMD is currently 6.46%. Under the proposal it would be 5.96%, a reduction of 7.74%. Assuming the same $1 million in retirement funds, that would mean withdrawing $5,000 less. If you were in the 22% tax bracket you would save $1,100; in the 37% bracket you would save $1,850 in taxes.

An extra $100 or more a month isn’t trivial for many retired Americans. The additional wealth accumulation is also an added bonus. My estimates suggest that an individual age 72 in 2020 with $1 million in a retirement plan could reasonably have over $75,000 more in after-tax net worth at age 95.

If the IRS adopts the proposed regulations, they won’t take effect until 2021. For individuals withdrawing from traditional IRAs the transition to the new rules appears simple; you will just start using the new tables in 2021. If you have inherited an IRA, however, the transition to the new tables is more difficult because there is data needed and calculations involved.

The proposed changes will mean nothing for most IRA owners who withdraw more than the RMD. Yet it will be a nice gift to those who are in the envious position of not needing all their RMD for living expenses.

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