The SECURE Act 2.0: RMD Edition

The SECURE Act 2.0: RMD Edition

January 17, 2023

The SECURE Act 2.0 of 2022 makes it easier to accumulate retirement savings at every stage of the financial journey. The Act also took steps to potentially enhance retirement savings for those close to or in retirement. Required minimum distributions (RMDs) can be burdensome from both an income and a tax planning perspective. The Act creates breathing room by extending the age at which RMDs kick in and builds some opportunities to prepare a multi-year plan to maximize income and minimize taxes.

Understanding RMDs

Currently, retirement savings that were contributed to tax-deferred accounts, such as 401(k)s and IRAs, must start to be withdrawn beginning at age 72. The goal of RMDs is to ensure that taxes are paid on the funds. The amounts are determined by a formula that includes the account balance at the end of the previous year and a life expectancy factor published by the IRS. This can result in the RMD increasing over time.  

Changes to RMDs in the SECURE 2.0 Act

The SECURE 2.0 Act raises the age at which RMDs begin to 75, but it does so in a two-stage process. The first stage gives retirees nearing age 72 a window to take advantage of lower asset values. For those in early retirement, the second stage expands the time to undertake financial and tax planning strategies. 

Beginning in 2023, the age for RMDs is 73. This is an immediate change. For folks who are turning 72 this year and would have otherwise been required to start your RMD, you have an extra year.

You can still take a distribution if you need it but are no longer required to. You may also be in a situation where it makes sense to look at a Roth conversion for some or all of your retirement assets.  

Beginning in 2033, the age for RMDs jumps to 75. For those in early retirement, the extra years before RMDs kick in can offer additional opportunities to optimize income and taxes throughout retirement. Having additional time can allow for:

  •  A more gradual Roth conversion timeline that allows for tax planning
  • Time for strategic planning of taxable income events, such as asset sales

What Happens if You Don’t Take a Required Distribution? 

The previous penalty for failing to take distribution was 50% of the amount shortfall amount, which was one of the harshest penalties in the tax code. The SECURE 2.0 Act changes this to 25%, and if you take the total amount by the end of the second year after it was due, the penalty is reduced to 10%.  

The Bottom Line

The tax benefits of saving into tax-deferred accounts become a tax liability when the savings amassed have to be withdrawn in retirement. The sweet spot for many people for a Roth conversion is before RMDs kick in, and having a few more years to enact thoughtful strategies can mean more flexibility around both income and taxes. 

While the greatest benefit is for people who have several years before reaching age 73, having an extra year when asset values have declined provides an opportunity to convert funds to a tax-free account and lower the value of tax-deferred 401(k)s and IRAs subject to RMDs. 

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