In 2022, Congress passed a sweeping $1.7 trillion bipartisan bill to improve retirement for millions of Americans. The Secure 2.0 Act made massive changes to the 2019 Secure Act via 92 new provisions that included modifications to ABLE accounts, catch-up contributions, 529 plans, and arguably most importantly, required minimum distributions.
Required minimum distributions (RMDs) affect nearly every American. Why? Because Americans are required by law to begin withdrawing from their retirement accounts annually once hitting a certain age. If they fail to withdraw at the specified age they run the risk of incurring a tax penalty.
If you’re nearing retirement or have already retired, it’s crucial to have a clear understanding of RMDs and how recent legislative changes may impact your retirement savings. Below we touch on the Secure 2.0 Act RMD changes, when they take effect, and what you need to know to avoid tax penalty.
Required Minimum Distributions (RMDs) Background
RMDs are mandatory withdrawals that individuals with certain retirement accounts, such as traditional IRAs and employer-sponsored retirement plans, are required to take once they reach a certain age. The purpose of RMDs is to ensure that individuals do not accumulate tax-advantaged retirement savings indefinitely but instead use them for retirement income.
RMDs are calculated based on age, account balance and the individual’s life expectancy. The IRS provides specific tables to determine the annual withdrawal amount.
As mentioned, RMDs are only required of select retirement accounts. Roth IRA owners, for instance, are not required to withdraw funds until after the death of the owner. In this example, the beneficiaries of the Roth IRA are subject to the new RMD rules highlighted below.
Secure Act of 2019
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was signed into law in December 2019, made significant enhancements to RMDs, most notably increasing the starting age to 72 for individuals who reached that age on or after January 1, 2020. The Act also eliminated the age limit for contributing to a traditional IRAs, so long as the individual is still earning an income.
Other provisions included changes to inherited IRAs, qualified birth or adoption distributions, and retirement access for small employers. At its core, the SECURE Act sought to enhance the planning and distribution of retirement savings for individuals across the country.
However, less than 4 years later, the Secure 2.0 Act was passed in an effort to make retirement even more accessible for Americans.
Secure 2.0 Act: RMD Basics & Rules
The Secure Act left many questioning whether Congress had done enough to improve retirement savings options. But before naysayers could protest its passage, Congress was hard at work bolstering the original bill with vaster and more attainable improvements.
The Secure 2.0 Act unveiled 92 provisions, including new RMD rules. If retirement is on the horizon or if you’re diligently planning your retirement, here’s how the Secure 2.0 Act RMD rules will impact you.
Increase in RMD Age
Under the Secure 2.0 Act, the age at which individuals are required to start taking RMDs increased from 72 to 73, starting January 1, 2023. The Act also delays RMDs to 75 starting in 2033.
Per the IRS, if you turn 73 in 2023, the required beginning date for your first RMD is April 1, 2025 for the year 2024. However, if you turned 72 in 2022, your first RMD is due by April 1, 2023 based on your account balance on December 31, 2021 and your next RMD is due by December 31, 2023 based on the account balance on December 31, 20222.
This change provides individuals with additional time to grow their retirement savings tax-deferred.
RMD Penalties
If you’ve reached age 73 and mistakenly forgot to kickstart your retirement withdrawals, you could face tax penalties. As part of the Secure 2.0 Act, the IRS has reduced the excise tax penalty from 50% to 25% and further reduced from 25% to 10% if the RMD is corrected within two years.
Pre-Death Requirement
Under previous law, pre-death distributions were required in employer-sponsored Roth accounts. Starting January 2024, there is no pre-death RMD requirement for Roth 401(k) accounts.
Changes to Inherited IRAs
For traditional IRA account owners who pass away after December 31, 2019, the entire account balance must be distributed within 10 years of the owner’s passing date. There are, however, exceptions to this requirement. Surviving spouses, children under 18 years of age, a disabled or chronically ill beneficiary, or a person not more than ten years younger than the account owner are excluded from this requirement.
Tax Considerations
For beneficiaries inheriting the IRA, be aware of an impending tax bill. Prior to 2020, beneficiaries of traditional IRAs could stretch their withdrawals over their life expectancy allowing the tax-deferred growth of the IRA to continue for many years.
If you were lucky enough to inherit the traditional IRA prior to 2020, you can still take advantage of that strategy. But if you inherited the traditional IRA anytime on or after January 1, 2020, you are required to follow the new inherited IRA rules mentioned above, which comes with its own tax considerations.
For beneficiaries who fall outside of the exclusion list, you may want to consider not withdrawing the entire lump sum and paying taxes up front, which could pose a detriment to your tax bracket standings and push you into a much larger bracket in one year.
Instead, consider rolling over the funds into an inherited IRA (spoiler, you can’t roll the money into your own IRA, so you would need to create a new account) with the understanding that those funds are required to be withdrawn within 10 years time. By spreading out withdrawals over 10 years instead of an immediate lump sum withdrawal, you may be able to reduce the tax hit from the IRA.
While we can consider the Secure 2.0 Act and its predecessor a step forward for America’s retirement, this is one drawback to carefully consider.
Benefits of the Secure 2.0 Act
By the time of retirement age, the average American will have amassed just $255,200 in their retirement fund. That’s quite a gap from the $1.8 million Americans say is the magic retirement savings number.
The passing of the Secure 2.0 Act marks a significant step forward in helping Americans bolster their savings and secure a more stable financial future. By expanding access to retirement savings plans, lower tax implications, and raising the age for required minimum distributions, Americans are one step closer to long-term financial security.
Take advantage of the new Secure 2.0 Act RMD rules and regulations to help extend your retirement savings and your overall financial legacy. Consulting with a financial advisor can help individuals make the most of the opportunities provided by the Secure 2.0 Act and help consider how your retirement funds fit into your overall estate plan. Connect with a member of the Prudent Investors team to see how the Secure 2.0 Act applies to you.
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