A few weeks ago, President Trump issued an executive order directing the Treasury Department and the Department of Labor (DOL) to investigate the possibility of making two significant changes to retirement savings in America.
The first proposal involves raising the required minimum distribution (RMD) age for traditional 401(k) and traditional IRA investors.
What are the Current RMD Rules?
Current RMD rules state that initial RMDs must be made from most retirement accounts by April 1 of the year following the year the account holder turns 70 ½. For those born in between January and June, that will be April 1 of the year after they turn 70; for those born between July and December, that will be April 1 of the year after they turn 71.
For all subsequent years, RMDs have to be taken by December 31, including the year of your first RMD. This means that in the first year after you turn 70 1/2, you will be taking two RMDs from your IRA.
Let’s look at two hypothetical people, Clark and Terry:
- Clark was born on March 23, 1950. He turns 70 ½ in September of 2020 and will have to take the first RMD from his IRA by April 1, 2021 and the second RMD by December 31, 2021.
- Terry was born on October 12, 1950. Because she doesn’t turn 70 ½ until April of 2021, she won’t have to take the first RMD from her IRA until April 1, 2022 and the second RMD until December 31, 2022.
These rules apply to all employer-sponsored plans such as 401(k)s; these include profit-sharing plans, 403(b)s, and 457(b)s. (Special rules apply to pre-1987 contributions to 403(b)s.) The rules also apply to Roth 401(k) accounts and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
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Are There Any Exceptions to the RMD Rules?
Yes. One notable exception are Roth IRAs. Distributions from Roth IRAs are not required until the death of the account owner.
There is also one, very specific, exemption for 401(k) plans. As long as they do not retire, workers may opt out of taking the RMD from their current employer’s 401(k), provided they do not own more than 5% of the company. However, RMDs must still be taken from any 401(k) accounts with former employers.
What’s the Penalty?
Failure to take an RMD will result in a hefty tax penalty. First, you’d pay a tax of 50% on the amount of the RMD that was not taken. Second, you will owe the regular income taxes you would have owed on the RMD itself.
What’s the Problem?
The problem is that using 70 ½ as the kick-off age for RMDs is that people are living longer. The Treasury Department’s life-expectancy tables haven’t been updated since 2002. According to these, the average American lives to age 77; however, average life expectancy is actually 78.6.
What’s the Proposed Solution?
The U.S. Chamber of Commerce, along with several large financial-services firms, recently suggested that the RMD start date be pushed back to age 75, stating that doing so would encourage Americans to continue saving during their early retirement years.
Is There a Catch?
Some critics think the proposal isn’t all it’s cracked up to be. Most people aren’t working by the time they reach age 70 ½ – those who are working are not required to take a minimum distribution from their 401(k) plan until they retire.
Other retirement experts say that raising the RMD age will likely only benefit the ultra-wealthy by delaying their tax bill on the withdrawn amounts—possibly indefinitely, if they pass their retirement accounts along to their heirs, who will pay a lower tax bill at the time of distribution.
What’s the Second Part?
The second proposal aims at reducing the costs and administrative burden associated with running a retirement plan for small employers, such as a Multiple Employer Plan (MEP). President Trump ordered the Department of Labor to consider cutting down on some of the red tape small businesses that want to offer their employees retirement plans must contend with.
The DOL has also been tasked with investigating whether retirement-plan reform might allow part-time employees, sole proprietors, and other workers with non-traditional employer/employee relationships access to an employer-sponsored retirement plan that would otherwise be out of reach.
Is There a Timeline?
The two government agencies were given a six-month deadline to report their findings on these issues. In any event, only Congress can change the rules and regulations surrounding tax law and employee benefits; therefore, President Trump’s executive order has limited power unless Congress acts on it.
Wondering how these proposed changes may potentially affect your retirement security? Get started with a free Results In Advance Planning evaluation of your current plan or portfolio.