Delaying required minimum distributions allows retirement savers to keep earning returns on their money and also possibly put themselves in a better tax situation — but this policy still serves some investors more than others, a recent study found.
Those who wish to leave an inheritance benefit the most from delaying required minimum distributions, according to a paper recently distributed by the National Bureau of Economic Research. Required minimum distributions are mandatory for qualified employer-sponsored accounts, such as 401(k) plans, and traditional individual retirement accounts (IRAs) beginning at 72 years old. The amount to be withdrawn is calculated with factors including life expectancy and account balances.
The SECURE Act passed in December 2019 increased the age from 70½ years old. Congress is mulling over another age change, which could push the age requirement to 75 years old.
Increasing the age for RMDs would have little effect on financial behaviors, including how individuals save in a retirement account or claim Social Security, the study found. What it would do is help wealthier retirees hold off on distributing a portion of their assets — especially those with plans to leave a legacy.
See: What’s new with RMDs in 2021?
People who want to leave money to their heirs don’t benefit from a lower RMD age, because they would rather use the account as a “tool” to transfer wealth to younger loved ones, the researchers said. With required minimum distributions, investors are forced to take a portion of their accounts out of a tax-advantaged plan, which means they lose out on potential future gains. The money from these accounts is also taxed at distribution. (By comparison, Roth IRAs do not have a required minimum distribution because the money in those accounts was taxed before it was contributed.)
Of course, not everyone is in a situation where they can afford to wait until 72 years old to take required minimum distributions — many savers tap into their retirement accounts earlier than that.
The penalty for failing to take an RMD is 50% of the amount that should have been distributed. For example, if a person’s required minimum distribution was $2,000 in one year, they would pay an additional penalty fee of $1,000.
The researchers named alternative solutions for required minimum distributions in their paper, aside from increasing the withdrawal age, including: the “progressive RMD” approach, where only retirees who have assets more than $100,000 would need to take a distribution, and eliminating the RMD altogether. The former has been proposed by Senators Rob Portman and Ben Cardin in the “Retirement Security and Savings Act of 2019.”
These proposals could benefit all savers. “The reality is many Americans are not very financially literate,” said Olivia Mitchell, the executive director of the Pension Research Council and an author of the paper. “As a result, they tend not to manage their retirement savings and decumulation very attentively and may forget to withdraw the RMD amounts.”
