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Retirement Perspectives

The new law increases the age to 72 for retirement account owners to start taking RMDs.

My last column covered big news in the retirement industry: The Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed into law in late December 2019. The SECURE Act contains the most comprehensive retirement account legislation in more than a decade. In our second column covering the new legislation, we’ll explain one of the major changes: The increased required minimum distribution (RMD) age for all retirement accounts. Plus, we’ll discuss how the new law impacts qualified charitable distributions (QCDs).

To reflect increased life expectancies and fortify retirement savings, the SECURE Act increases the age at which individuals must start distributing retirement plan assets to 72 from 70½. Notably, the age of 70½ that was established for account owners to begin taking distributions from retirement plans was first applied almost 60 years ago (early 1960s), and this age has never been adjusted to take into account increases in life expectancy.

Before we get into the details, let’s review how a RMD works. Owners of an IRA (including SEP and SIMPLE, but not Roth) must begin taking withdrawals upon reaching a certain age—regardless of whether they need or want the income. Simply not taking a distribution is not prudent—not taking or taking less than the full RMD subjects the account owner to a hefty 50% penalty tax on the amount that was supposed to be taken but wasn’t. For example, if you missed your 2019 RMD of $20,000, you owe the IRS $10,000. Ouch!

Under the new law, the required beginning date (RBD) is moved to age 72 from 70½, effective for individuals who reach age 70½ after December 31, 2019. Therefore, the timing of the initial RMD will now be age 72—not 70½. An added benefit: individuals will longer need to determine their 70½ birthday. I think most reasonable people would agree it’s easier to figure out your 72nd birthday instead of 70½; therefore, the RMD process should become somewhat simpler.

 

The change in the new required beginning date (RBD) for RMDs only applies to those individuals who turn 70½ in 2020 or later.

 

In the new law, required minimum distributions (RMDs) for qualified retirement plans (i.e. 401(k)), 403(b) and 457(b) plans) generally must commence by the later of April 1 of the calendar year following the calendar year in which an employee attains age 72—or the calendar year in which the employee retires, known as the “required beginning date” (RBD). The RBD for certain 5% business owners is April 1 following the year in which they attain age 72, even if they continue to work for the employer sponsoring the retirement plan. The rule is similar for IRAs (excluding Roth) —the RBD is April 1 of the calendar year after attaining age 72.

Tip: The increased RMD age is in addition to IRS proposed changes in the RMD life expectancy tables beginning in 2021. Both changes will allow your nest egg to bake slightly longer before having to take requisite withdrawals.

What if an individual attained age 70½ during 2019? Does the new increased RMD age mean these individuals can delay their RMDs?
No. The SECURE Act changes the age for participants who attain age 70½ after December 31, 2019. Therefore, IRA owners (including SEP and SIMPLE), 5% or more business owners, and retirees who turned 70½ during 2019 will still be required to take their minimum distributions by April 1, 2020.

Example #1: Tim turned 70 on January 10, 2019; therefore, he attained age 70½ six months later in July 2019. Tim decided to delay taking his 2019 RMD until April 1, 2020. Tim is not affected by the new law. In other words, the RMD rules for Tim have not changed. Tim still must take his 2019 RMD by April 1, 2020.

Example #2: Myron turned 70 on September 25, 2019. However, he will not turn 70½ until February of 2020. The new law allows Myron to delay taking his first RMD until April 1 of the year following the year he reaches age 72.  In other words, Myron will be subject to his initial RMD in 2021 when he turns 72. His deadline for taking his 2021 RMD is April 1, 2022.

Another way to grasp the change in RMD age is by looking at one’s birthday. For example, were you born before 1949? If so, you are already taking RMDs and the new rule does not impact you.

Were you born in the first half of 1949 (January 1 through June 30)? Again, the new rule does not affect you, because you reached 70½ in 2019 and therefore are subject to a 2019 RMD. For your first (2019) RMD, you had the option of taking the withdrawal either before the end of 2019 or delay the RMD until April 1, 2020.

Were you born in the second half of 1949 (July 1 through December 31)? If so, the new law does apply to you, because you will turn 70½ in 2020. Your first RMD will be due in the year you turn 72, which will be in 2021 based on your December 31, 2020 account balance.

Were you born after 1949? You need to wait until the year you reach 72 to take your first RMD.

 

An individual is still required to be age 70½ to qualify to make a qualified charitable distribution (QCD). Starting in the year an individual turns 72, a QCD can reduce or satisfy their RMD.

 

What does the new RMD age of 72 mean for qualified charitable distributions (QCDs)?
Surprisingly, the SECURE Act does not change the date at which individuals may begin to use their IRA to make QCDs. Even though an individual turning 70½ in 2020 will not have to take an RMD for 2020, they may still make a QCD up to the annual limit of $100,000.

 

We’ll have more to say about the SECURE Act, including an explanation of what other key provisions mean for retirement investors. Stay tuned.

Advisors, if you have additional questions, please contact your Lord Abbett representative at 888-522-2388.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

A 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees' accounts.

A 457 plan is available for certain state and local governments and non-governmental entities tax exempt under IRC Section 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).

A defined contribution plan is a retirement plan that's typically tax-deferred, e.g. a 401(k), at employers. An employee contributes a percentage of his/her paycheck in an account to fund retirement. The sponsor company will generally match a portion of employee contributions.

A required minimum distribution (RMD) is the minimum amount an account owner must withdraw from a retirement account each year. An owner generally has to start taking withdrawals from a retirement plan account at age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

qualified charitable distribution (QCD) allows individuals who are 70½ years old or older to donate up to $100,000 annually to one or more charities directly from a taxable IRA instead of taking their required minimum distributions.

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