New Law Lets You Take IRA Withdrawals Later

Uncle Sam wants to be certain he collects taxes eventually on those tax-deferred accounts, and RMDs are his tool. Once savers reach the RMD age, they must withdraw an amount calculated each year based on their remaining life expectancy. For every $100,000 in an IRA, a saver age 72 would be required in most cases to withdraw $3,650. At age 75, the RMD on $100,000 would be $4,065; at age 85, the RMD on that amount would hit $6,250.

With SECURE 2.0, “raising the RMD age tells us that the government realizes that people are living longer and working longer — the day of the hard-and-fast finish line at age 65 is phasing out,” says Mike Lynch, managing director of applied insights at Hartford Funds. Delaying RMDs “means you’ll have more time to save, more time to prepare and more tax-deferred growth before you have to tap those accounts.”

Once you do tap those accounts, you’ll owe taxes on the withdrawals. The mandatory income from RMDs has long created headaches — pushing households into higher tax brackets, raising the tax hit on Social Security benefits, and imposing bigger premiums for Medicare parts B and D. Higher-wealth savers who can afford to spend less than their accounts’ RMD level and want to minimize their taxes have long benefited from smart planning to reduce their RMDs — or avoid them altogether.

The 2019 law ratcheted up the value of such planning by putting stricter distribution limits on tax-deferred accounts left to a saver’s beneficiaries. A child who inherited a parent’s IRA before 2020 could take distributions based on the child’s life expectancy, spreading out the income — and the tax hit. But under the SECURE Act, most beneficiaries other than the IRA owner’s spouse must drain an account inherited in 2020 or later within 10 years. Given that heirs might be in their own peak earnings years, “those distributions could hit their taxes hard, bumping them into a higher bracket,” warns Roger Young, vice president and thought leadership director at T. Rowe Price Advisory Services.

How to soften the tax hit

So how can savers reduce or avoid RMDs? The answer is Roth — an alternative approach for IRAs or 401(k)s under which savers stash away money that’s already been taxed. A Roth plan sacrifices the immediate tax savings offered by traditional tax-deferred savings. In return, contributions and (under most circumstances) investment earnings are never taxed.

Workers can choose to save in Roth 401(k)s if their employer offers that option. SECURE 2.0 made Roth 401(k)s even sweeter, repealing the requirement that older retirees take RMDs from these accounts. “The government wants its money sooner, so it’s making it more attractive to take the Roth approach,” says Young. “Fortunately, for a lot of people that’s a good decision.”

Roth IRAs were never subject to RMDs, either for the owner or their heirs. Savers who want to manage their RMDs can convert part of their tax-deferred savings to Roth status. That means paying taxes up front on the portion of their savings that they convert. Paying taxes now may be painful, but it could allow you or your heirs to avoid paying even higher taxes later. The goal, says Vanguard’s Gandhi, is to maximize “family wealth — making sure you keep more money in the family, rather than giving it to the government in taxes.”

This planning isn’t simple. If you’re considering Roth conversions — whether to reduce your own lifetime tax burden or to help your heirs — you ought to work with a professional financial adviser who can weigh all the tax, income and estate aspects of your decisions. But there are some general rules of thumb for Roth conversions, taking into account:

• Tax rates: Generally, you should move money into Roth accounts when the taxes you pay on the converted funds now are less than the taxes you (or your heirs) would expect to pay in the future. “We’re now in one of the best periods in recent history for taxes, with lower rates than we’re accustomed to,” says Gandhi. New retirees frequently have a few lower-tax years before their RMDs kick in. With SECURE 2.0, that window of opportunity has expanded.
• Tax brackets: Each spring, The Hartford’s Lynch likes to ask clients, “Have you filled out your bracket?” — not for March Madness, but for taxes. If your projected income is going to land you in the lower end of a tax bracket, you have an opportunity to convert traditional IRA funds to Roth without triggering a higher rate. For example, in 2023, a married couple with an income of $90,000 could convert $100,000 in traditional IRA funds to Roth without moving from the 22 percent bracket into the 24 percent bracket.
• Other sources of cash: In that example, a $100,000 conversion would cost $22,000 in taxes. You could pay that from the IRA funds — but you’ll get a greater tax advantage if you can pay those taxes from other sources.
• Medicare and Social Security: Higher-income retirees pay extra premiums for Medicare parts B (doctor services) and D (prescription drugs). Additional income recognized in a Roth conversion could trigger those surcharges, offsetting some of the benefit.
• Your heirs’ situation: If your children or other heirs have strong earnings, they’ll benefit if you convert to Roth any IRAs you expect to leave to them. If your children have chosen different paths — one’s a doctor, another’s a social worker — you can tailor your estate, leaving Roth assets to the higher earner and tax-deferred accounts to the lower-paid child.
• Plans for charitable giving: SECURE 2.0 also sweetened the rules for qualified charitable donations (QCDs), funds that go directly from an IRA to a qualified charity. QCDs can be used to satisfy RMDs — but do not count as income. If you’re planning to use your IRA to fund substantial charitable gifts, you don’t want to pay taxes on a Roth conversion.

With so many moving pieces, you’ll want to be sure to get good professional advice before you act. And a pro can help you keep up with future changes as well. “Congress is taking an active interest in retirement issues,” notes David Blanchett, head of retirement research at PGIM, the investment management business of Prudential Financial Inc. “We can’t agree on anything in this country — but we can agree on improving retirement security.”