President Trump last week asked the Treasury Department to review the rules surrounding Required Minimum Distributions (RMDs) for traditional Individual Retirement Accounts and 401(k) plans. Updating RMD life expectancy tables, which are now 15 years old, makes sense. But slowing the amount people must withdraw from their IRAs and 401(k)s (and pay taxes on) will do little or nothing to enhance the retirement security of most older adults. The vast majority would realize annual tax savings of less than $100.
Nearly half of American retirees say they have less than $100,000 in retirement savings. Many low- and moderate-income retirees already withdraw more than the legal minimum to help pay living expenses. They would not benefit at all from potential changes to the rules.
The biggest share of defined contribution retirement assets are in the hands of a relatively few high-income households. Those who use big-dollar retirement accounts as estate planning vehicles would the real winners from the changes Trump is suggesting.
Complicated rules
Keep in mind that despite Trump’s high-profile executive order, there is very little that Treasury can do to revise RMDs. That’s a job for Congress, and House Republicans may try to end required distributions for very small accounts in an upcoming tax bill.But those who hope Trump’s initiative eventually will result in Treasury fully eliminating the requirement are being wildly unrealistic.
The tax law requires people to start taking withdrawals from IRAs and 401(k)s during the year they turn 70 ½ and continue each year thereafter. Generally, those who do not face penalties of up to 50 percent of the required distributions.
There are some exceptions, including one for people who are still working at age 70 ½. But in general, the rules are complicated and complying can be especially challenging for those who have multiple retirement accounts. RMD distribution rules do not apply to Roth-type IRAs and 401(k)s, where withdrawals are tax-free.
Annual minimum distribution amounts are based on IRS life expectancy tables. However, those tables were last updated in April, 2002 when life expectancy was more than one year shorter than it is today.
Trump’s Aug 31 executive order included this request:
Within 180 days of the date of this order, the Secretary of the Treasury shall...examine the life expectancy and distribution period tables in the regulations on required minimum distributions from retirement plans and determine whether they should be updated to reflect current mortality data and whether such updates should be made annually or on another periodic basis.
The accompanying White House fact sheet was more open ended. It said:
The Department of the Treasury is to review the rules on required minimum distributions from retirement plans to see if retirees could keep more money in 401(k)s and Individual Retirement Accounts for longer. This could allow retirees to spread retirement savings over a longer period of time.
Who would benefit?
Reviewing those mortality tables to reflect changes in life expectancy is sensible. Congress could delay the starting age for RMDs, or Treasury could slow the schedule for annual required distributions. But although Trump titled his executive order Strengthening Retirement Security for American Workers, few seniors would notice the changes at all.
In 2015, the roughly 17 percent of taxpayers with adjusted gross incomes of $100,000-plus took more than half of the $253 billion in IRA distributions. Only about 20 percent went to those making $50,000 or less. In 2016, working age households in the bottom half of the income distribution had IRA and 401(k) account balances averaging only about $54,000, according to the Federal Reserve’s Survey of Consumer Finances. Yet another survey found that nearly one-third of people in their 60s or older had less than $100,000 in defined contribution plan assets. They’d hardly notice modest changes in the required distribution formula.
In addition, about one-quarter of those 71 or older already withdraw more from their retirement accounts than the RMD demands, according to the Employee Benefit Research Institute. They would not be affected at all by changes in the minimum distribution rules. Indeed, some researchers suggest that many retirees would be well served by using the RMD formula as a way to avoid outliving their money.
$27 in tax savings
The current RMD requirements already are extremely generous. They assume the life expectancy of someone 70 ½ is more than 27 years, far longer than it really is. That’s because the tables combine the life expectancy of the retirement plan participant with a hypothetical beneficiary who is ten years younger.
With that in mind, let’s do a little math. Assume you have $274,000 in an IRA (far more than average). And assume Treasury adds 1.6 years to its life tables. Instead of having to withdraw $10,000 annually (1/27.4th), you’ll need withdraw only $9,448 (or 1/29th). If you are in the 25 percent tax bracket, your annual tax savings will be $138 ($2,362 instead of $2,500). If you have $137,000 in your retirement plan and are in the 10 percent tax bracket, your annual tax savings would be $27.60.
Your lifetime tax savings would actually be even less since you’ll owe more taxes later, but you get the point.
The purpose of tax-favored savings is to support retirement, not to subsidize the wealthy who squirrel away assets for their heirs. That’s why RMDs are required in the first place.
Many retirement advisors hope that Trump’s order will lead to repeal of the RMD rules. They argue that doing so would equalize the tax treatment of traditional DC plans with that of Roth’s. Treasury doesn’t have the legal authority to do that. But even if it did, such a step would do little more than benefit those who least need the extra money in retirement.
