Legislators in Washington are presently discussing two measures that would significantly alter how Americans save for retirement and are taxed in retirement. And one of the primary focuses of these proposals is the reform of Required Minimum Distributions (RMDs).
In 2019, the SECURE Act increased the required minimum distribution age from 70.5 to 72. This was a huge boon for the elderly, who can retain funds in their tax-free retirement plans for longer. In the view of many legislators, however, there was insufficient assistance for retirees. As a result, a few influential members of Congress began planning new legislation to assist more individuals in preparing for retirement and keeping their money for longer.
Both the EARN Act and the SECURE Act 2.0 were introduced to Congress due to these efforts. The House of Representatives enacted the SECURE Act 2.0 in March by a vote of 414 to 5, and the EARN Act was also passed.
Numerous analysts are optimistic that a big retirement measure will be passed before the end of the year. But we still need to find out which bill has the best chance of passing Congress and becoming law. (The bills could also be amended or merged into a single measure.) Therefore, it is prudent to familiarize oneself with the prospective amendments to both laws. And for seniors or those nearing retirement concerned about mandated retirement account distributions, this entails familiarizing oneself with the six potential RMD amendments contained in the two bills. Check them out now, so you’re not taken off guard in 2022 if RMD reform is enacted. Both measures would make substantial modifications to RMDs. However, the RMD provisions of the two bills differ.
Minimum Age Before RMDs Are Required
Currently, RMDs must be taken from 401(k)s, traditional IRAs, and comparable accounts (other than Roth IRAs) when you turn 72. (although you may wait til April 1 of the next year to take your first RMD). However, the SECURE Act 2.0 and the EARN Act would increase the age at which RMDs can be started to 75. However, both plans vary in distribution regarding age.
Under SECURE Act 2.0, the transition would be gradual. Beginning in 2023, the minimum age for receiving RMDs would increase from 72 to 73. Then, starting in 2030, it would gradually increase to 74. And ultimately, in 2033, it would reach 75.
With the EARN Act, the change would occur abruptly but not immediately. The RMD age would remain at 72 until 2031, then instantly increase to 75 beginning in 2032.
There are severe consequences for failing to submit an RMD. If you miss an RMD or withdraw insufficient funds from your retirement account, you will be subject to a 50% excise tax on the shortfall. There is, however, some penalty relief possible. You may be eligible for an exemption if you failed to take an RMD due to a “reasonable error” (such as a major illness) and you withdraw the required amount from your retirement account as soon as possible. To request a penalty waiver, send Form 5329 to the IRS as advised and include an explanation for why you did not take your RMD. The IRS will let you know if your request is denied.
The current tax rate of 50% is one of the highest penalties in the entire tax system, so it is not surprising that legislators wish to reduce it. In all instances, penalties would be reduced to 25% under the SECURE Act 2.0 and the EARN Act. In addition, the penalties would be reduced to 10% if the RMD is taken by the end of the second year after the year it was due. For instance, if you failed to withdraw an RMD due in 2022, the penalty would be reduced to 10% by withdrawing the funds before December 31, 2024. If both laws were adopted this year, the clauses regarding the decrease of penalties would take effect in 2023.
As part of the SECURE Act 2.0, the statute of limitations for assessing penalties for specific individuals would also be delayed. For those who did not have to file a tax return for that year, the limitations period would begin on the date when the return was filed, even if it was later than the normal due date. If no tax returns were required for the year, the limitations period would begin on the due date of the return (excluding extensions). By starting the clock sooner, some individuals may be able to escape the penalty if the IRS is sluggish to assess it.
Required Minimum Distributions for Roth 401(k) Accounts
Roth IRAs are not subject to RMDs. Currently, however, RMDs are required for Roth 401(k) accounts. You can circumvent the Roth 401(k) RMD regulations by transferring the funds to a Roth IRA. But beware of the Roth IRA five-year rule; if you’re not diligent, you may have to wait five years before withdrawing your money.
The EARN Act would eliminate the requirement to transfer Roth 401(k) funds to a Roth IRA if approved. Like Roth IRAs, Roth 401(k) accounts would not be subject to RMD restrictions before the account holder’s death. (The post-death minimum distribution regulations also apply to Roth IRAs.) This modification would normally take effect beginning in 2024, except for RMDs necessary before 2024 but not due until January 1, 2024, or later.
Pensions and RMDs
With SECURE Act 2.0 and EARN Act, several difficulties associated with using annuities in conjunction with retirement savings accounts would be addressed. For example, if an employer-sponsored defined contribution plan (e.g., a 401(k) plan) contains an annuity, the employee’s account is split between the portion containing the annuity and the portion that does not work to apply the RMD regulations. This can lead to increased RMDs. The EARN Act would allow you to immediately aggregate payouts from both halves when calculating your annual RMD.
IRS regulations further restrict how annuity payments may be made if the annuity is offered in conjunction with an employer’s retirement plan. According to a summary of the SECURE Act 2.0 provided by the House Ways and Means Committee, the restrictions are intended to “limit tax deferral by prohibiting commercial annuities from giving payments that begin small and climb significantly over time.” Nonetheless, these limits discourage employees from including annuities in their employer-sponsored retirement portfolios.
To make annuities a more attractive component of employer retirement plans, the SECURE Act 2.0 and EARN Act would provide certain conditions are met and permit the following payments:
- A minimum increase of 5% per year in annuity payments;
- A lump sum payment that shortens the payment period of an annuity or commutates future payments of annuities
- The acceleration of annuity payments scheduled to be received within the next 12 months through lump sum payments;
- Dividend payments or similar distributions
- Upon death, final payments must not exceed the total consideration paid for annuity payments minus the aggregate amount of prior distributions or payments.
Under the SECURE Act 2.0, this modification would take effect in 2023, but it would take effect immediately under the EARN Act.
In both employer-sponsored retirement plans and individual retirement accounts (IRAs), the SECURE Act 2.0 and EARN Act will increase the use of qualifying longevity annuity contracts (QLACs). The maximum amount you can invest in a QLAC is $130,000 (2022) or 25% of your retirement account. Both measures would eliminate the 25% limit and establish that (1) divorce survivor benefits are payable and (2) the employee has 90 days to terminate the QLAC.
Additionally, the EARN Act would increase the monetary amount to $200,000 (adjusted for inflation each year). The repeal of the 25% cap and the increase in the dollar amount would take effect the day after the law is approved. The clarifications would apply retroactively to all QLACs acquired after July 2, 2014.
RMDs for Widows and Widowers
Existing regulations specify when a surviving spouse must begin taking RMDs from an inherited retirement plan. For the surviving spouse of an account holder who dies before RMDs are required (and does not change that position), RMDs from the inherited account are not required until the year the dead account holder has reached age 72.
Beginning in 2024, the EARN Act would also permit the surviving spouse to be considered as the deceased account owner for RMD purposes. The surviving spouse would have the option of delaying RMDs from the inherited account in certain situations, for example, if he or she is younger than the deceased spouse.
The surviving spouse would need to elect this option under rules that the IRS would need to adopt, and the election would be irrevocable. Additionally, he or she must tell the account administrator.
Distributions to qualified charitable organizations (QCDs) are Used to Reduce RMDs.
Donations made through a qualified charitable donation (QCD) count toward your required minimum distribution (RMD). QCDs are a terrific option for seniors with a philanthropic bent to lower the amount of money they would otherwise have to take from an IRA. However, the annual ceiling on QCDs is $100,000, and this sum does not increase annually.
In both the SECURE Act 2.0 and the EARN Act, the $100,000 cap would be adjusted annually for inflation (to the nearest $1,000). Adjustments would commence in 2023 under the SECURE Act 2.0 but not until 2024 with the EARN Act.
The two measures would also provide a one-time QCD of $50,000 in the form of charitable remainder annuities, charitable remainder unitrusts, and charitable gift annuities. If adopted in 2022, the SECURE Act 2.0 version would take effect for the 2022 tax year. However, the EARN Act version would not take effect until 2023.