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When Clients Work Past 70, RMDs Are Still Required — And Begrudged
FYI: When Ron Strobel was an investment adviser in Seattle, many of his clients were Boeing engineers. They loved their jobs and wanted to keep working as long as they could.
But when they reached age 70½, they had to take required minimum distributions from their individual retirement accounts. They didn't like it.
"Sens. Rob Portman, R-Ohio, and Ben Cardin, D-Md. ,,, said the original RMD age was set in the 1960s and has not been changed."
That would have been remarkably prescient as IRAs were created in 1974 by ERISA. Originally there were no RMDs. They were created as part of the Tax Reform Act of 1986.
[W]ith the increase in defined contribution plan assets, there was a growing concern that taxpayers were using these retirement vehicles as a means to accumulate tax-free wealth rather than as a means to ensure an adequate retirement income. To address the issue, the Taw Reform Act of 1986 was passed requiring taxpayers to being taking annual distributions from their tax-deferred defined contribution plans upon reaching the age of 70½.
When we save into tax deferred retirement account we push taxes (on income) into the future.
It would be an interesting stat to compare present day tax savings in the year that the IRA contribution was made to the tax liability on that contribution (and its potential investment growth) over time. The longer that we have for investments to potentially grow the better the potential outcome.
If I pay taxes on $100 at a rate of 20% in the year I earn that income I net $80 after taxes. If instead, I let the $100 grow tax deferred and I remain in a 20% tax bracket in retirement the government stands to collect not only it's initial 20%, but also 20% of any growth that the $100 made. I keep 80%.
It seems to me that the closer one is to withdrawing IRA funds (whether RMD or not) the less impactful (investment success) these tax deferred contributions can potentially be.
In fact, if you were one year away from retirement withdrawals and that $100 tax deferred contribution fell in value to say $50 (that would suck for you) and then it was withdrawn from the IRA, the taxes collected would be halved as well (that would suck for Uncle Sam).
This is why contributions made closer to retirement should be carefully invested on the risk spectrum. Those dollar potentially have less time to grow meaningfully.
My dense brain required two readings to grasp all of this. Spot-on, except the very last couple sentences aren’t quite computing for me. (“This is why ...”)
If I may restate your observations, I believe you’re highlighting the fact that when we invest in tax deferred accounts we are also investing on behalf of the government. That’s because eventually Uncle Sam does get to tax our contribution and in addition any growth on that contribution that has accrued over the years. As you note - your success and that of the government’s rise or fall together.
Overall the government may be seen to be riding on our backs and sharing in (what ought to be) our long term investment success. I continue to like Roth IRAs for the reason being you get to keep whatever you’ve earned over the years. And, if someone wants to roll the dice and do a later life Roth conversion into an asset they think has been unjustly beaten down and stands to rebound - than BINGO - you get to keep 100% of your winnings.
I always thought when earnings were put into a 401K or IRA ect. ect. the taxes that were avoided where usually higher (say 28%) rate then taxes would be on an RMD because the withdrawal is usually in a lower bracket (say 10% ideal would be zero). Is this not true? Also RMD's come from the whole pool not just the last years investment. Main point is to do your investment over as many years as possible. Just what am I missing?
That is what the plan providers would tell people. But when you reach 70.5, the RMD kick in. (Divide your expected tax deferred income by 27.4 for the first year, and each year the divisor goes down.)
Also add in your income, which will include up to 85% of your Social Security income. Add other incomes in there and you might end up with a big taxable income. Then with that big taxable income, your Medicare part B & D might cost a lot more.
Next year is my RMD, but my tax deferred income is fairly low as I've been contributing to my Roth since it began. The rest is in taxable. I went to 95% cash on my IRA to keep the taxes down. My taxable and Roth do the heavy lifting.
Gary brings up a great point, When I was working (late 60s until around 2000) the standard line was: “Defer income while you’re in a high bracket and pay a lower tax rate on it after you’re retired and earning less.” That may have happened in my case - but I’m not so sure. For one, back when that creed was in vogue Social Security wasn’t considered taxable income. Today at least a portion of it is if you also receive a pension and exceed a certain level of income:
“Congress passed and President Reagan signed into law the 1983 Amendments. Under the '83 Amendments, up to one-half of the value of the Social Security benefit was made potentially taxable income.” https://www.ssa.gov/history/taxationofbenefits.html.
A pension (with cola) has pushed me over 20+ years into a higher tax bracket than I expected when working. The % taken doesn’t seem appreciably lower than during the working years. In addition, Michigan also levied an income tax on pensions - previously exempt.
I think when it comes to this kind of dynamic (figuring out what tax bracket you’ll be in 30 years down the road) you’re best to play it safe. No one really knows. I’m not sure using a Roth at an early age is the answer. Might be. But if, as a seasoned investor, you can play the percentages and convert a portion into an asset you think is undervalued - it’s worth paying those taxes a few years earlier than you might have otherwise and doing the conversion (in stages over several years).
BTW - Roths aren’t subject to RMD. What’s not to like?
I think I agree: Be happy you have an income on which to pay taxes. My point was that younger (working) folks need to be cognizant of and consider the potential ramifications when making decisions regarding tax-deferred investments vs other approaches.
It is possible to delay RMDs if one is still working, but the issue is so complex that most of us would be unable to read the IRS rules. I spent some time reviewing the discussions of the issue online and came away more confused than when I started. It is said that the IRS has never defined the term "still working" for the purposes of determining if the taxpayer can delay RMDs. I also know that delaying can result in having to take two RMDs in a single tax year, an event that could easily bump one into a higher bracket. Anything that begins with "by April 1 of the year after one turns 70.5" is sure to confound even the most literate and informed. It gets worse from there. CPAs and the like have a steady source of employment because of such confusing statutes.
I did a google search on "can one delay RMD's past age 70.5" and found several linked articles but none of which pertain to mutual funds so consider this input useless or of little value.
It seems that you can if you are still working for the same employer/company as you've always been and there seems to be a few other work arounds as well.
I converted all of my IRA's to Roth IRA's back when the Roth's became available so I really haven't kept up on this topic.
"It is possible to delay RMDs if one is still working"
It is true that one can delay RMDs from an employer retirement plan before retirement. The article was discussing RMDs for IRAs though ("It's ridiculous that the IRS forces them to begin withdrawing from their IRAs"). One cannot delay RMDs for an IRA - that's the point of the article.
" It is said that the IRS has never defined the term "still working""
That's correct, since the term "still working" doesn't appear in the IRC or in the regs. The expression used in the Regulations is "retires from employment with the employer maintaining the plan" (401(a) and 403(b)). In plain English it's essentially the same thing, so perhaps a distinction without a difference.
Again, this RMD exception applies only to employer sponsored retirement plans, not to IRAs.Note that employers have the option of imposing RMDs at age 70½ even on current employees. That could be a source of some of the confusion.
Regarding "April 1 of the year after one turns 70.5", that's not too complicated, though the ramifications may be. If you turn 70½ in 2019, you have an RMD this year. Your deadline for this first RMD is April 1 of the next year, 2020.
That can lead to two RMDs in the same year 2020, one for 2019 and one for 2020. That would boost your income in 2020. That's your choice, how you plan your taxes, just as bunching deductions every other year is your choice, how you plan your taxes. The IRS is giving you flexibility. If it's confusing, just ignore the flexibility and do everything on a calendar basis.
@msf - Thank you for that correction. That's an important distinction. In my head that means that if you contribute to a retirement account with your employer, be it 401k, IRA or whatever else they call it and you remain employed past the age of 70.5 you can take a pass on RMD's? Or can somebody give me an example of what an employer's retirement plan is that isn't what I think it is (e.g. 401k, IRA)?
As the article notes, there are a few exceptions to the rule that you can skip RMDs with employer accounts: if you're a 5% owner of the company, or if the plan docs (not the IRS) require you to take RMDs at 70½. But generally you don't have to take RMDs if you're still working there.
You raised two new questions: does this cover all types of employer plans, and what about continuing to contribute.
If I may offer a side comment, I think Congress went a little wacko in creating all these hybrid plans, SIMPLE, SEP-IRA, SARSEPs. There are "clean" employer plans, 401(k)s, 403(b)s. There are IRAs. Then there are these genetic mutations. I try not to look at them unless I have to (and I have had a SEP IRA).
Can you continue contributing? Something that I was never worried about, but a quick search turned up this ThinkAdvisor piece. If it is to be believed (I haven't checked tax code, etc. to verify), you can continue contributing to 401(k)s, and the employer must continue contributions to SEPs. But you can't contribute to a traditional IRA. But, but, you can continue contributing to a Roth IRA. https://www.thinkadvisor.com/2016/08/22/the-post-70-retirement-plan-contribution-rules/?page_all=1
Comments
That would have been remarkably prescient as IRAs were created in 1974 by ERISA.
Originally there were no RMDs. They were created as part of the Tax Reform Act of 1986.
https://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1049&context=legal
https://www.bnymellon.com/us/en/our-thinking/baby-boomers-and-required-minimum-distributions.jsp
From the latter page:
It would be an interesting stat to compare present day tax savings in the year that the IRA contribution was made to the tax liability on that contribution (and its potential investment growth) over time. The longer that we have for investments to potentially grow the better the potential outcome.
If I pay taxes on $100 at a rate of 20% in the year I earn that income I net $80 after taxes. If instead, I let the $100 grow tax deferred and I remain in a 20% tax bracket in retirement the government stands to collect not only it's initial 20%, but also 20% of any growth that the $100 made. I keep 80%.
It seems to me that the closer one is to withdrawing IRA funds (whether RMD or not) the less impactful (investment success) these tax deferred contributions can potentially be.
In fact, if you were one year away from retirement withdrawals and that $100 tax deferred contribution fell in value to say $50 (that would suck for you) and then it was withdrawn from the IRA, the taxes collected would be halved as well (that would suck for Uncle Sam).
This is why contributions made closer to retirement should be carefully invested on the risk spectrum. Those dollar potentially have less time to grow meaningfully.
Thoughts?
My dense brain required two readings to grasp all of this. Spot-on, except the very last couple sentences aren’t quite computing for me. (“This is why ...”)
If I may restate your observations, I believe you’re highlighting the fact that when we invest in tax deferred accounts we are also investing on behalf of the government. That’s because eventually Uncle Sam does get to tax our contribution and in addition any growth on that contribution that has accrued over the years. As you note - your success and that of the government’s rise or fall together.
Overall the government may be seen to be riding on our backs and sharing in (what ought to be) our long term investment success. I continue to like Roth IRAs for the reason being you get to keep whatever you’ve earned over the years. And, if someone wants to roll the dice and do a later life Roth conversion into an asset they think has been unjustly beaten down and stands to rebound - than BINGO - you get to keep 100% of your winnings.
Also add in your income, which will include up to 85% of your Social Security income. Add other incomes in there and you might end up with a big taxable income. Then with that big taxable income, your Medicare part B & D might cost a lot more.
Next year is my RMD, but my tax deferred income is fairly low as I've been contributing to my Roth since it began. The rest is in taxable. I went to 95% cash on my IRA to keep the taxes down. My taxable and Roth do the heavy lifting.
Dave
“Congress passed and President Reagan signed into law the 1983 Amendments. Under the '83 Amendments, up to one-half of the value of the Social Security benefit was made potentially taxable income.” https://www.ssa.gov/history/taxationofbenefits.html.
A pension (with cola) has pushed me over 20+ years into a higher tax bracket than I expected when working. The % taken doesn’t seem appreciably lower than during the working years. In addition, Michigan also levied an income tax on pensions - previously exempt.
I think when it comes to this kind of dynamic (figuring out what tax bracket you’ll be in 30 years down the road) you’re best to play it safe. No one really knows. I’m not sure using a Roth at an early age is the answer. Might be. But if, as a seasoned investor, you can play the percentages and convert a portion into an asset you think is undervalued - it’s worth paying those taxes a few years earlier than you might have otherwise and doing the conversion (in stages over several years).
BTW - Roths aren’t subject to RMD. What’s not to like?
It seems that you can if you are still working for the same employer/company as you've always been and there seems to be a few other work arounds as well.
I converted all of my IRA's to Roth IRA's back when the Roth's became available so I really haven't kept up on this topic.
Here's one from Forbes in May, 2018 to get you started:
https://www.forbes.com/sites/bobcarlson/2018/03/23/when-rmds-from-retirement-accounts-arent-required/#411487ad909d
It is true that one can delay RMDs from an employer retirement plan before retirement. The article was discussing RMDs for IRAs though ("It's ridiculous that the IRS forces them to begin withdrawing from their IRAs"). One cannot delay RMDs for an IRA - that's the point of the article.
" It is said that the IRS has never defined the term "still working""
That's correct, since the term "still working" doesn't appear in the IRC or in the regs. The expression used in the Regulations is "retires from employment with the employer maintaining the plan" (401(a) and 403(b)). In plain English it's essentially the same thing, so perhaps a distinction without a difference.
Again, this RMD exception applies only to employer sponsored retirement plans, not to IRAs.Note that employers have the option of imposing RMDs at age 70½ even on current employees. That could be a source of some of the confusion.
Regarding "April 1 of the year after one turns 70.5", that's not too complicated, though the ramifications may be. If you turn 70½ in 2019, you have an RMD this year. Your deadline for this first RMD is April 1 of the next year, 2020.
That can lead to two RMDs in the same year 2020, one for 2019 and one for 2020. That would boost your income in 2020. That's your choice, how you plan your taxes, just as bunching deductions every other year is your choice, how you plan your taxes. The IRS is giving you flexibility. If it's confusing, just ignore the flexibility and do everything on a calendar basis.
You raised two new questions: does this cover all types of employer plans, and what about continuing to contribute.
If I may offer a side comment, I think Congress went a little wacko in creating all these hybrid plans, SIMPLE, SEP-IRA, SARSEPs. There are "clean" employer plans, 401(k)s, 403(b)s. There are IRAs. Then there are these genetic mutations. I try not to look at them unless I have to (and I have had a SEP IRA).
Apparently they (SEPs and SIMPLEs) follow the IRA RMD rules. No exceptions. See
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
Can you continue contributing? Something that I was never worried about, but a quick search turned up this ThinkAdvisor piece. If it is to be believed (I haven't checked tax code, etc. to verify), you can continue contributing to 401(k)s, and the employer must continue contributions to SEPs. But you can't contribute to a traditional IRA. But, but, you can continue contributing to a Roth IRA.
https://www.thinkadvisor.com/2016/08/22/the-post-70-retirement-plan-contribution-rules/?page_all=1
Is this anyway to run a tax code?