Carefully coordinate your strategy to deploy savings in retirement with the IRS rules on required … [+]
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The IRS recently finalized new regulations that determine the minimum amounts that retirees must withdraw from their retirement accounts and include in their taxable income. These new rules will apply to withdrawals made during 2022 and thereafter.
Background
The IRS requires retirees to withdraw minimum amounts from taxable IRA accounts and any 401(k), 403(b), and 457 accounts in employer-sponsored retirement plans. The age at which the required minimum distribution (RMD) rules first apply depend on your date of birth.
- If you were born on or after July 1, 1949, then the rules first apply for the calendar year during which you reach age 72.
- If you were born on or before June 30, 1949, then the rules first apply for the calendar year during which you attain age 70-1/2.
One more detail: The RMD rules were suspended as part of the CARES Act for 2020 only. They’ll apply again in 2021.
The RMD rules don’t apply to Roth IRAs, any amounts in Health Savings Accounts (HSAs), or money in savings and investment accounts that don’t have special tax advantages.
As they stand, the RMD rules specify “distribution periods” that result in annual withdrawal rates that increase for each age for which they apply. To determine the minimum amount you need to withdraw, you apply the applicable withdrawal rate to the value of your account as of December 31 in the year immediately preceding the year in which the withdrawal is required.
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Impact of the new rules
Under the new RMD rules, the minimum amounts that will be required to be withdrawn will reduce by about 6.5% to 7.5% each year compared to the current rules.
For example, let’s suppose you have $100,000 in savings on December 31, 2021, and that during 2022 you’ll attain age 72. The rules will apply to you for the first time for calendar 2022. Under the current rules, you’d be required to withdraw 3.9063% from your account during 2022, or $3,906. Under the new rules, you will be required to withdraw 3.6496%, or $3,650. This latter amount is 6.6% less than the amount required under the current rules.
Effect on the Spend Safely in Retirement Strategy
The new RMD rules don’t change the viability of the Spend Safely in Retirement Strategy, which is a straightforward strategy for generating lifetime retirement income from virtually any IRA or 401(k) account.
The baseline strategy calls for three steps:
- Optimize your Social Security benefits with a careful strategy to delay your benefits as long as possible, but no later than age 70. If you retire before age 70, enable the delay by either working part time or implementing a Social Security bridge payment.
- Invest your retirement savings in a low-cost balanced, target date, or stock index fund—these funds are commonly found in 401(k) plans or IRA platforms. Use the IRS RMD rates to determine the amounts that you can withdraw each year to help pay for living expenses. Use the same RMD methodology to calculate your annual withdrawal if you retire before the age at which RMD applies to you.
- Set aside some money for an emergency fund, so you don’t need to withdraw from the savings that are generating your retirement income.
The changes in the payout rates under the new RMD rules are minor, so they don’t impact the viability of the Spend Safely in Retirement Strategy. And you’re always allowed to use the current RMD payout rates, rather than the new rates, throughout your retirement, since they’d result in withdrawal amounts that are higher than the minimum amounts that the IRS will require you to withdraw.
At the end of this post is a link to a printable table that compares the current RMD withdrawal rates to the rates under the new regulations. This table also shows the withdrawal rates starting at age 60, using the RMD methodology for those ages before the rules actually apply. Our research shows that the RMD withdrawal rates are a viable, straightforward method at any age to deploy your savings to generate lifetime retirement income.
Of course, there are other viable methods you can use to generate retirement income from your savings. It would be a good use of your time to explore these alternative methods to find the one that best meet your goals and circumstances.