Trump order delivers a bit of good news on retirement accounts
President Donald Trump signed an order at the end of August requesting the Treasury Department review certain rules for required distributions from retirement accounts.
While unlikely to induce radical change, it’s worth discussing narrowly the likely effects of the Trump order. It also gives me an excuse to talk about required minimum distributions, or RMDs, more broadly and crack a few RMD jokes.
RMDs set the minimum amount that investors in taxadvantaged retirement accounts such as traditional IRAs and 401(k)s must take out and pay taxes on, beginning in the year after they turn 70½ years old. Money distributed from these accounts is taxed as ordinary income.
A primary purpose of the RMD is to make sure that the federal government, which didn’t tax our contributions to these taxadvantaged accounts, gets a chance to tax the distributions. As good as these accounts are, remember that you can’t permanently evade the taxman.
A secondary purpose of the RMD is to act as a kind of minimum guidepost to retirees and their advisers facing the age-old question: “How fast should I draw down my nest egg?”
The way RMDs work is that an IRS table indicates how long a retirement account owner is expected to live, on average, then forces withdrawals based on that expected life span.
I remember learning about the IRS tables for RMDs and thinking, “That’s weird; the IRS knows exactly when I’m going to die.” I guess that explains why the FBI has decided to monitor all my conversations through the fillings in my teeth.
Anyway, your RMD in any given year is calculated by taking your retirement account’s value and dividing it by your expected remaining years. So an 87-yearold man with a $100,000 retirement account, expected to live according to the IRS Single Life Expectancy Table for 6.7 more years, would need to withdraw and be taxed on $14,925.37 from that account this year, because that’s his account value divided by 6.7.
Speaking of life expectancy, a completely different IRS table addresses the “older spouse, younger spouse” problem.
Considering the kind of creepy old men who traditionally have written our tax laws, you will not be surprised to learn that an entire IRS table — technically known as Table II ( Joint Life and Last Survivor Expectancy) — exists to determine the correct RMDs for what we might call the Anna Nicole Smith scenario. You’ll remember she was 26 years old when she married 89-year-old tycoon J. Howard Marshall back in 1994. That Table II allows the younger spouse to delay distributions for a much longer time.
But back to the presidential order from August. The Trump order tasked the Treasury Department with updating life expectancy tables used by the IRS, since they haven’t been changed since 2002. Despite your strongly held belief that everything is worse these days than it used to be and the world is probably ending soon, the truth is that improvements in medical care mean that life expectancies keep moving steady upward. The effect of updated IRS tables will be to lower RMDs. For a small number of people who don’t need or want to take their full RMD, this update will provide some small good news.
How small and how good? Adviser to investment advisers Michael Kitces calculates that the update will provide the equivalent of one Starbucks coffee worth of additional net worth for a retiree with a $100,000 retirement portfolio. For a $1 million portfolio, we’re talking about two weeks’ worth of java, excluding weekends.
RMDs constitute a minimum floor for retirement account withdrawals. Many folks will need to withdraw more than the minimum requirement, if income from Social Security, a pension or taxable accounts isn’t enough to cover lifestyle costs. Updating RMD restrictions matters more to people looking to take less than currently required.
There are other ways of minimizing the effect of RMDs, if you kind of hate RMDs and wish they’d go away altogether instead of get tinkered with on the margins.
You already know, I’m sure, that Roth IRAs require no RMDs. You don’t need to take any money out of these accounts at all in your lifetime. Roth 401(k)s, incidentally, do have RMDs, so they’re less cool.
Obviously, also, RMDs only apply to tax-advantaged retirement accounts. You are kindly invited to hoard your pile of Scrooge McDuck savings and investments deep into old age and beyond through your taxable accounts.
Finally, my mom taught me a neat trick about delaying RMDs on your employer-sponsored 401(k) plan. A few years past age 70, she officially retired from the private school where she had taught for 30-plus years but then agreed to stay on salary, part time.
She didn’t purposefully sign up as a part-timer to delay her RMD, but was pleased to learn that as long as she was on salary, she could indefinitely delay her RMD from her school’s employer-sponsored account. She doesn’t absolutely need the salary or the distribution, and so I think she likes the idea that some of her 401(k) investments continue to grow undisturbed, in a tax-advantaged way, well past age 70.5.
Again, this isn’t for everyone — to continue to work and not withdraw investments — but it’s a useful workaround for the right situation, and it stretches untaxed investment dollars a bit further.