In recent weeks, there has been a flurry of proposals to potentially modify Required Minimum Distribution (RMD) obligations, from President Trump’s Executive Order, to legislative proposals in both the House and the Senate. In some cases, the proposals would provide some “RMD relief” for those who don’t want or need to take withdrawals during life, although another proposal would actually increase required minimum distributions for beneficiaries after death!
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1 PM EST broadcast via Periscope, we examine the arguments for updating the RMD rules, delve into the proposed changes from both President Trump and Congress, discuss why the media hype over “RMD relief” might be much ado about nothing, and why despite the recent discussions of RMD relief that the greater risk is still for a potential RMD crackdown (especially on stretch IRAs) in the coming year or few!
The first proposal to consider is President Trump’s recent Executive Order, which focused mainly on MEPs (Multiple Employer [Retirement] Plans), but also included a directive to the Treasury Department to update the life expectancy tables used to calculate required minimum distributions. Which is arguably overdue, as the last time the tables were updated was 16 years ago, and recent medical advances have certainly increased life expectancies since then. Which means, at least ostensibly, that there’s an increased risk that RMDs will deplete retirement accounts too quickly.
However, the reality is that life expectancy increases have not been terribly dramatic – no more than about 2 years of joint life expectancy for a 70-something retiree. Which means, on a percentage basis, the first RMD would actually decrease only about 25 basis points – from 3.65% of the account balance to just 3.4% instead – or a whopping $250 of reduced RMDs per year on an account with a $100,000 balance. And of course, the taxes due on that RMD at a moderately affluent 22% tax rate is only $55 of real tax savings. Which itself is just tax deferral (since the taxes on the IRA will still be due someday, RMD or not!).
And unfortunately, the other leading proposal for RMD “relief” isn’t much better. In the House, Congress is currently considering a package of the three pieces of legislation, colloquially know as “Tax Reform 2.0”, which mainly seek to make last year’s Tax Cuts and Jobs Act permanent, but also propose to create a new Universal Savings Account (USA) for tax-free savings (with a $2,500 per year contribution limit but no limitations on how withdrawals must be used), and more importantly for retirees would eliminate RMDs on employer retirement plans with balances under $50,000 (along with repealing the age limit on regular IRA contributions for 70-somethings who are still working to allow them to still contribute while also taking RMDs).
Yet again, while these additional RMD proposals make sense, none of them would make a material difference for most clients of financial advisors, especially when we consider that RMDs on a $50,000 401(k) are relatively small to begin with, and IRA contributions must come from earned income (and not that many 70-somethings are still in the workforce) and still may not be enough to offset RMDs anyway.
Meanwhile, what hasn’t received much attention at all is a far more important proposal buried in the Retirement Enhancement and Savings Act of 2018 (RESA), currently under consideration in the Senate, which would eliminate the stretch IRA for most non-spouse beneficiaries, who would then be subject to the far-harsher 5-year rule instead!
The bottom line, though, is simply to understand that the RMD relief proposals that have been getting the most attention lately won’t likely have any meaningful impact for most clients, while the impact from the one that would make a material difference from a planning and tax perspective would be very negative indeed! Of course, there’s no telling how long Congress will continue to kick the can down the road – proposed legislation can linger for months, or years, or “forever” before ever actually being passed into law – but the point remains that despite the recent buzz for RMD relief, the greater risk for those with sizable retirement accounts is still that RMDs may become more restrictive in the future, not less!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone. Welcome to Office Hours with Michael Kitces.
For today's Office Hours, I want to talk about the buzz that's been going around the advisor community lately about all the recent proposals to modify RMD, required minimum distribution rules, from President Trump's recent executive order, to a number of different pieces of legislation that are currently being proposed in the House and the Senate. Now, unfortunately, I think most of this is going to turn out to be much ado about nothing, not because the proposals won't come to fruition, they might, but unfortunately, most of them don't actually help the planning process very much for our advisors and our clients, and some of them may actually hurt.
President Trump’s Executive Order To Update RMD Life Expectancy Tables [00:50]
So the first proposal in this category is a part of President Trump's recent executive order on retirement plans. The primary focus of the executive order was making changes to what are known as the Multiple Employer (Retirement) Plans or MEPs for short, M-E-Ps. And the executive order really was meant to patch a couple of challenges in current MEPs. So it directs the Treasury and IRS to update regulations on MEPs to eliminate what's known as the "bad apple" rule, where one bad apple employer who makes a mistake and runs afoul of the IRS qualified plan rules can disqualify the plan for everybody, all the employers in the MEP. And the executive order also directs Department of Labor to ease some of the administrative burdens on Form 5500 filings, because ideally with a MEP, it's supposed to be one consolidated plan that simplifies all the administrative hassle, except in practice, often each employer still has to file their own 5500 even when it's an aggregated MEP. So the President's executive order would have DOL ease those rules a little.
But the executive order was also a directive to the Treasury Department to update the life expectancy tables that are used to calculate RMDs. It was kind of thrown in at the end, but it's a big deal. You know, the life expectancy tables, most of us know this as Appendix B of IRS Publication 590, are the tables we use to calculate those annual RMDs. There's actually three tables there: the Uniform Life Table, which we use to calculate lifetime RMDs, the Joint Life Table, which we use to calculate RMDs during life...when we have a spouse who's more than 10 years younger, and then the third is the Single Life tables, which are used to calculate all the post-death RMDs for beneficiaries once the account owner passes away, so also known as the stretch IRA tables.
Now, the life expectancy tables were all written back in 2002, which was the last time the RMD rules were changed. And they haven't been updated since, notwithstanding all the advances in medical technology increasing life expectancy. So the executive order directs the Treasury Department to update the tables over the next 180 days or 6 months. Now, the good news here is that there really is a good case to be made for updating the tables just to maintain pace with improvements in life expectancy. They really haven't been updated in 16 years. And because this is just an update to existing regulations and tables, it should be well within the Treasury's capability to do so, based solely on the President's executive order and without needing some separate law from Congress.
Now, realistically, tables probably won't get updated until we're into 2019, which means they probably won't take effect until 2020, but nonetheless, the end result is that if we update the life expectancy tables and increase all those life expectancy factors because everyone is living longer, higher life expectancy factor means smaller RMD obligations starting in 2020, which is good news.
Unfortunately, though, it's not very good news. The media hype around this proposal has been that, "we have to update the life expectancy tables to prevent consumers from unnecessarily depleting their retirement accounts by drawing too quickly based on inappropriately short life expectancies!" But the reality is, first and foremost, the safe withdrawal rate is already higher than RMD obligations usually are by the time you're in your 70s, so retirees tend to spend more than that anyways, and more simply, life expectancy just hasn't changed that much since 2002. For instance, as it stands today, the first lifetime RMD upon reaching age 70 1/2 is a 27.4-year life expectancy, which is technically the joint life expectancy of a 70-year-old and a 60-year-old beneficiary. And if you divide that into a dollar amount, what you find out is that the first RMD factor requires a withdrawal of 3.65% of the account balance.
Now, imagine for a moment we do this update to the RMD tables. If you look at the available data on life expectancy from the OECD, average life expectancy since 2002 for 65-year-olds has increased a little less than 1 1/2 years. So it would even be a little bit lighter of an increase for someone who is already 70. Joint life expectancy for a married couple means between the two of them joined life expectancy is up maybe two years if we're generous with the rounding. So that first life expectancy factor age 70 1/2 goes from 27.4 to 29.4, which means that the first RMD goes from 3.65% of the account to 3.4% of the account. Your RMD goes down by 0.25%. Or to put that in real dollars, your RMD on a $100,000 retirement account decreases by 250 bucks. That's it.
And of course, you only pay taxes on a percentage of that income. So if we assume a moderate affluent retiree in the 22% tax bracket retirement, the changes would be $55 of actual tax savings on a $100,000 account. That's right... $55 of tax savings. And it's actually even worse than that because it's not even really $55 of tax savings because an IRA is still pre-taxed. You will still have to pay the $55 in taxes when you take the money out of that IRA someday, you just get to defer the $55 tax bill by taking smaller RMDs.
So if we assume a typical moderate growth rate on a retiree's portfolio, this update to life expectancy, the growth you would earn on the 55 bucks on the 0.25% on the $100,000 basically means new life expectancy tables will buy you 1 cup of coffee from Starbucks in 2020. If you have a $1 million account, it'll buy you 2 weeks of Starbucks coffee but only if you buy Monday through Friday and still homebrew on the weekends. Simply put, for an individual retiree, updating and increasing the life expectancy tables to reduce RMD sounds great, in reality, it's just a trivially small percentage of the account reducing annual RMD obligations by less than a quarter of 1%.
IRA Contribution And RMD Changes Proposed Under The Family Savings Act of 2018 [06:33]
Now, the second proposal on the table to change the RMDs from retirement accounts comes from the Family Savings Act, also known as H.R. 6757, which is one of the three pieces of legislation currently under consideration in the House as part of the House Republicans' so-called "Tax Reform 2.0" efforts. Now, the primary thrust of Tax Reform 2.0 is just to make Tax Reform 1.0 permanent, so to take all the changes from the Tax Cuts and Jobs Act, new tax brackets, the Section 199A pass-through deduction for businesses, the increased standard deduction, the reduced itemized deductions, and make all that permanent.
But part of the Tax Reform 2.0 legislation is this bill called the Family Savings Act of 2018. And the Family Savings Act has a couple of key provisions in it. It would increase availability of MEPs, so there's a congressional proposal for it in addition to the President's executive order, there's a section that would create a new kind of tax-free savings account called a Universal Savings Account, or USA for short. Think of it as like a mini-Roth IRA with a $2,500 a year contribution limit but no limit on how the money is used, unlike Roths that have to be for retirement or 529 plans that have to be for college.
But buried in the Family Savings Act are two other notable provisions specifically pertaining your retirement account. The first, under Section 109 of the legislation, would propose that RMDs from retirement plans be eliminated completely for anyone who has less than $50,000 in the account at the end of the year. Now, this isn't entirely new. It was actually proposed first by President Obama in his budget proposals to Congress back in 2017. So the proposal has some bipartisan support for curtailing RMDs entirely for small account balances.
And the first version was actually even more expansive and would have said if you have less than $50,000 when you turn age 70 1/2, you are permanently exempt from RMDs on your retirement account. The proposal on the Family Savings Act is actually a little bit narrower. It would only exempt employer retirement plans like 401(k) plans, not all retirement accounts, so small IRAs would still be subject to it. And the account would have to be re-evaluated every year. Which means if only thanks to not taking RMDs the account grew over $50,000 then RMDs would kick back in on the larger account until either you withdrew enough to get it below the line or a bear market or poor investment returns drive you back below the line.
Now, I'm not sure how useful this provision will necessarily be for us as advisors. We don't tend to work with retirees who have less than $50,000 in their retirement accounts, but if it passes, it may at least become a popular strategy to start leaving behind at least $50,000 in a 401(k) plan when you roll the rest over to an IRA just to carve a little off to the side in a manner that avoids RMDs. So you might have to take $40,000 over there, because if you actually did $50,000 the first day it grew, you would have RMDs again. So you have to stay under the line to leave a little room.
The second proposal on the Family Savings Act under Section 104 would repeal the age limit on IRA contributions, making it possible to keep contributing to an IRA even after you have to start taking RMDs. So basically, the RMD would come out, but then you can put it right back in, or at least some of it up to the annual IRA contribution limit. Now, the caveat to this is, you can already contribute to a Roth IRA if you're over age 70 1/2, so this really just brings parity between the two. You'll now be able to contribute to either a traditional or a Roth if you're over 70 and a half, and with obviously the caveat you still have to have earned income to contribute to...
Now, of course, the caveat to all of this is that you have to have earned income in order to contribute to any IRA in the first place, which means you still have to be a 70-something that's working, which it limits how useful it is because most 70-something people are already retired. And of course, if your income is already declining in your 70s, you may have actually preferred to do a Roth IRA at a low tax bracket than a traditional IRA anyways, especially since the Roth IRA would still have no RMDs after 70 1/2. The traditional IRA you can contribute after 70 1/2, but you have to RMD some of that money right back out.
And of course, the caveat to all of these proposals is that it's not even clear if Family Savings Act or the rest of Tax Reform 2.0 is going to get through Congress anyways. And it may be more about posturing for midterm elections at this point than legislation likely to pass, even if the RMD provisions in particular have some bipartisan support to carve out that exemption for small accounts under $50,000. So in the end, I'm sorry to say that most of the buzz about RMD reform is likely much ado about nothing. While I do think there's a good chance that President Trump's executive order does lead to an update in the RMD tables for 2019, taking effect in 2020, the practical impact is that it only reduces RMDs by one-quarter of 1%, which even on a $100,000 account creates enough tax value to maybe buy you 1 cup of coffee in 2020.
In the meantime, the proposals for allowing IRA contributions after 70 1/2 and eliminating RMDs on 401(k) plans under $50,000 as part of the Family Savings Act is probably just another piece of legislation that's proposed and not likely to come to pass. We'll see what happens, but in practice, it doesn't look like Tax Reform 2.0 is going through.
The Outlook For (Meaningful) RMD Reform [11:29]
Now, all that being said, it's worth noting that there is some other RMD reform bouncing around Congress that would be more meaningful and not in a good way. There was a proposal back in 2012 that would have changed the RMD rules after death by eliminating the stretch IRA and requiring most beneficiaries to be subject to the five-year rule instead. And that legislative proposal actually then reappeared as a budget proposal in President Obama's green book in 2015 and then again in 2017, and now it's appeared once more in legislation under the Retirement Enhancement and Savings Act, also known as RESA, that's currently being considered in the Senate.
Now, the original version of this proposal would have completely killed stretch IRA's five-year rule for everyone with just a couple of narrow exceptions. If you were a spouse, you could still do a spousal rollover. If you were a beneficiary of similar age, you know, within 10 years of the original person, the beneficiary could still stretch but only because they're going to be subject to the same RMDs that you would have in the first place. And if the IRA was left to a minor, they would at least be able to wait until the age of majority and then be subject to the five-year rule. But for everyone else, the classic "leave your IRA to your kids to stretch it out" would be dead and adult children will be subject to the five-year rule.
Now, under the RESA proposal, the rule is a little bit narrower. It would only apply to large retirement accounts defined as those more than $450,000. So if you had a $500,000 IRA that was being left to a 30-year-old adult child, the first $450,000 could be stretched over the child's nearly 50-year life expectancy, but the last $50,000 over the line would be subject to the 5-year rule. And if it was a bigger $2 million IRA then again, the first $450,000 could be stretched out nearly 50 years for the child, but the remaining $1.55 million would be subject to the 5-year rule instead.
Now, the other looming proposal out there that we haven't seen formally but is supposedly being considered would change the Roth IRA rules during life and add required minimum distribution. So just as we're considering taking the traditional IRA contribution limits and matching them up to Roths, which allow us to contribute over 70 1/2, we would also line up RMDs, which currently exists in traditional IRAs, and we'd add them to Roths over age 70 1/2 as well. Now, we'll see what happens. This has not hit a formal legislative proposal yet, but supposedly it is on the table as well.
But the fundamental point to all of this is that even if President Trump and Congress are proposing some of these RMD relief provisions about improving life expectancy tables and waiving RMDs for small accounts, I think the balance of risk for RMD reform is actually still that the rules could become much less favorable in the future by adding RMDs to Roth IRAs, or especially by curtailing the stretch IRA if RESA gets passed.
Now, it's hard to plan for any of these until they happen. There are a lot of proposals and crackdowns in Washington that get talked about and talked about for years and years and then never actually happen. But at a minimum, again, I thought it was important to point out that not only are some of the recent RMD relief provisions not actually likely that helpful for most advisors and our clients, but there's actually a risk of some much less favorable RMD changes lurking out there as well.
So in any event, I hope this is helpful as some food for thought, talking points with clients who may be asking about all this RMD relief stuff. This is Office Hours with Michael Kitces. Thanks for joining us, and have a great day.