New Retirement Withdrawal Restrictions Could Backfire Expensively

A new law that raises the minimum withdrawal age for retirement savings may have unintended and costly implications.

This year, the age at which retirees must begin receiving required minimum distributions from their IRAs, 401(k)s, and 403(b)s is 73, up from 72. Under legislation signed by President Biden in December, this will increase to 75 years old by 2033. The delay permits assets to grow tax-free for a more extended period and provides an opportunity to save more tax-deferred funds.

But delaying your RMD could result in bigger needed annual withdrawals later in life, pushing your income into a higher tax rate, which could influence the amount of Social Security and Medicare taxes you pay. It may also become a tax burden for your heirs.

In an interview with Yahoo Finance, Ed Slott- a New York certified public accountant and an IRA expert- stated that the more you delay the RMD age, the shorter the window to withdraw all of that money. And as you cram more income into a shorter period, you and your beneficiaries will pay more taxes.

RMD regulations

A retirement plan or regular IRA (including SEP and SIMPLE) cannot permanently hold funds. They must eventually be cashed out and taxed like regular income.

The new rule mandates that once you reach age 73, you must begin withdrawing money from your tax-deferred retirement account with an RMD. RMD is calculated by dividing your tax-deferred retirement account balance as of December 31 of the prior year by a life expectancy factor corresponding to your age according to the IRS Uniform Lifetime Table. 

As life expectancy decreases, the proportion of assets that must be withdrawn increases.

Under the new rule, failure to take an RMD means being subjected to a 25% penalty on the amount not dispersed- a reduction from the previous 50% penalty. And if you solve it quickly, the fine is reduced to 10%.

Fiscal Repercussions

If you have additional taxable income, such as your RMD, in addition to your Social Security benefits, this may affect the taxability of your benefits.

When filing your federal tax return as an individual and you have a combined income of $25,000 to $34,000 ( your adjusted gross income plus nontaxable investment interest plus half of your Social Security benefits), you may owe income tax on up to half of your benefits. If your income exceeds $34,000, up to 85% of your benefits may be subject to taxation.

Those filing a joint return with a combined income between $32,000 and $44,000 may be required to pay tax on up to 50% of their benefits. Taxes may apply to up to 85 percent of your benefits if your joint income exceeds $44,000.

In addition, if you postpone withdrawing assets, your RMD will be based on your diminishing life expectancy. Thus you would be forced to take a bigger RMD, which can cause your tax rates to rise, and you will ultimately face a higher tax bill.

The trade-off is that future RMDs could be greater, and predicting future income tax rates can be a gamble. If they are higher in the future, people would be worse off taking them early, according to a certified financial adviser and co-founder of Hemington Wealth Management, Eileen O’Connor.

Slott had a similar take, stating that those who do not need the money believe they are saving by delaying the RMD. In the long run, though, they may pay more taxes by waiting until age 73 and simply taking minimum distributions.

The possible influence on Medicare premiums

Delaying your RMD may potentially result in higher Medicare premiums. 

Your premiums are determined by your MAGI or modified adjusted gross income. This is your adjusted gross income total plus tax-exempt interest.

Simply put, if your income is higher, your premiums may be higher for Medicare Part B and Medicare prescription drug coverage. Individuals with a MAGI above $97,000 and married couples with a MAGI over $194,000 are subject to higher standard tax rates and premiums.

Heirs may also feel the sting.

O’Connor explains that the postponement of the RMD might complicate estate planning if heirs are involved, as they must exhaust inherited IRA payouts within ten years.

The reality is that the greater the amount of money you leave to your heirs in a retirement account, the greater the tax burden may be for them. Your heirs will likely inherit the ira during their peak earning years when they will be in the highest tax band of their lives. As a result, their tax burden will increase. O’Connor added that since the current life expectancy is 76, increasing the age for RMDs may leave a substantial amount of IRA assets to your heirs.