Delaying the minimum payouts required allows retired savers to continue getting returns on their money and potentially better tax exposure as well – but this policy still serves some investors more than others, according to a recent study.
Those looking to leave an inheritance will benefit most from the delay in the required minimum distributions, according to a paper recently released by the National Bureau of Economic Research. Minimum payouts required are mandatory for qualified employer-sponsored accounts such as 401 (k) plans and traditional individual retirement accounts (IRAs) aged 72 and over. The amount to be withdrawn is calculated taking into account factors such as life expectancy and account balances.
The SECURE Act passed in December 2019 raised the age to 70½ years. Congress is considering another age change that could increase the age requirement to 75 years.
Raising the age for RMDs would have little impact on financial behavior, including the way individuals save on a retirement account or make social security claims, the study said. This would help wealthier retirees avoid distributing some of their wealth – especially those planning to leave a legacy.
See: What's new with RMDs in 2021?
People looking to leave money to their heirs will not benefit from a lower RMD age as they would rather use the account as a "tool" to transfer wealth to younger loved ones, the researchers said. With the minimum payouts required, investors are forced to take some of their accounts out of a tax-privileged plan, meaning they will lose potential future profits. The money from these accounts is also taxed upon distribution. (In comparison, Roth IRAs do not have a minimum payout requirement as the money in these accounts was taxed before it was deposited.)
Of course, not everyone is in a situation where they can afford to wait until the age of 72 to make the required minimum distributions – many savers fall back on their retirement accounts earlier.
The penalty for not collecting an RMD is 50% of the amount that should have been distributed. For example, if an individual's minimum required payout is $ 2,000 in a year, they will pay an additional $ 1,000 penalty.
In their work, the researchers identified alternative solutions to required minimum distributions, aside from increasing the withdrawal age, including: the "progressive RMD" approach, which only requires retirees with assets of more than $ 100,000 to make a distribution, and the RMD as a whole to eliminate. The former was proposed by Senators Rob Portman and Ben Cardin in the Retirement Security and Savings Act of 2019.
These proposals could benefit all savers. "The reality is that many Americans are not very well educated financially," said Olivia Mitchell, executive director of the Pension Research Council and author of the paper. "As a result, they tend not to be very careful about managing their retirement savings and decumulation and may forget to withdraw the RMD amounts."