Articles About Retirement Planning

In December 2019, the Setting Every Community Up For Retirement Enhancement (SECURE) Act was passed into law, making many substantial updates to long-standing retirement account rules. While one rule repealed the maximum age for making Traditional IRA contributions (as now IRA owners beyond age 70 1/2, and in fact of any age, are allowed to contribute to their accounts, as long as they have compensation [generally earned income] to contribute), another such rule was created that, in essence, limits the amount of Qualified Charitable Distributions (QCDs) a Traditional IRA account holder can make, depending on the cumulative amount of those post 70 1/2 deductible contributions claimed.

Qualified Charitable Distributions (QCDs) are tax-efficient methods of making charitable donations with funds from a Traditional IRA (or inherited Traditional IRA). Essentially, an account holder (or beneficiary) age 70 1/2 or older can transfer up to $100,000 each year directly to charity. While the distribution from the account can count toward the account holder’s annual RMD, it is not included as Adjusted Gross Income (AGI), and thus does not need to (and cannot) be included as a charitable gift itemized deduction, making it a ‘perfect’ pre-tax donation.

With the passage of the SECURE Act, however, IRA account owners must now reduce their intended QCDs by any contribution amounts made into their IRAs after age 70 1/2 (the age cap in place to make IRA contributions before passage of the SECURE Act), to the extent they have not already been used to reduce their QCD. In other words, IRA contributions made after age 70 1/2 cannot be turned around to be used as QCDs… and the rules effectively require a “LIFO” treatment that ensures post-age-70 1/2 contributions will first and foremost be used to reduce future QCDs.

Going forward, there are four steps used to calculate allowable QCDs (to account for the potential impact of post-age-70 1/2 contributions):

1. Determine current-year distributions made and intended to be counted as QCDs;
2. Calculate total remaining distributions to be denied QCD status (this includes any deductible Traditional IRA contributions made by the account owner after reaching age 70 1/2 minus any QCD amounts disallowed in prior years);
3. Determine current-year distributions that will be denied QCD status (by identifying the lesser of the amount determined in steps 1 and 2); and
4. Determine current-year distributions which will be treated as a QCD (by taking the amount from step 1 and subtracting the amount from step 3).

Presumably, this QCD ‘anti-abuse’ provision is meant to prevent individuals from deducting Traditional IRA contributions (above-the-line deductions that reduce a taxpayer’s AGI) and then donating those contributions on a pre-tax basis (as a QCD), particularly in scenarios where they otherwise were not itemizing deductions and could not have otherwise made a pre-tax charitable contribution.

Despite this new provision, though, financial advisors can use numerous strategies to help clients benefit from QCDs. For example, Traditional IRA contributions can be voluntarily removed if done by October 15^th of the year following the year in which the contribution was made. Thus, an account holder who makes a contribution, who then decides they would instead prefer to make a QCD, can withdraw the contribution within the allowable timeframe, preventing any reduction to their QCD. Alternatively, married spouses who each have their own IRA account can choose to use one account to receive post-70 1/2 deductible contributions and the other to make QCDs. A third option would be for account holders to simply ‘burn’ through their post-70 1/2 contributions by making charitable donations from their IRAs that ‘use up’ QCD-disqualifying contributions as quickly as possible. While this means that taxable income will be reported for those account distributions, charitable gifts may be reported as itemized deductions, with future QCDs to be unaffected by these contribution amounts.

Some additional strategies available to advisors and their clients work to avoid the anti-abuse rule altogether. These include using other tax-efficient means to make charitable contributions (such as donating highly appreciated stock in a taxable account, which avoids potential capital gains taxes from selling the stock outright and, for those who itemize, allowing the contribution to be itemized as a charitable donation), contributing to employer-sponsored retirement plans (e.g., 401(k)s, and even SEP IRAs and SIMPLE IRAs) or Roth IRAs instead of Traditional IRAs (since contributions to Traditional IRAs only result in QCDs being denied), and choosing not to claim the deduction on Traditional IRA contributions (even if otherwise available) and deliberately making non-deductible contributions instead (to at least preserve the non-taxable treatment of those contributions for the future).

Ultimately, the key point is that the SECURE Act’s repeal of the age limit cap on Traditional IRA contributions has complicated the coordination of post-70 ½ contributions and QCDs with its introduction of the anti-abuse provision, which reduces allowable future QCDs by the amount of post-70 ½ IRA contributions. However, financial advisors can help their clients continue to make QCDs successfully with a range of planning strategies, some of which work with the anti-abuse provision, and some that avoid it altogether.

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Last month, the Setting Every Community Up For Retirement Enhancement (SECURE) Act was passed into law, creating the most substantial updates to the laws governing retirement accounts since the Pension Protection Act in 2006. One notable change resulting from the SECURE Act will be the increase in age at which Required Minimum Distributions (RMDs) must begin. Prior to the SECURE Act, individuals with IRA accounts or qualified employer-sponsored retirement plans were required to take RMDs beginning in the year in which they turned 70 ½  with a deadline (for the first RMD only) of April 1 of the following year.

Beginning in 2020, however, the new age at which RMDs must start is age 72 (also with a deadline of April 1 of the following year). Notably, RMDs for individuals who turned 70 1/2 in 2019 are not delayed, and instead, such individuals must continue to take their RMDs under the same rules prior to passage of the SECURE Act. Despite the delay in the starting age for RMDs, though, Qualified Charitable Distributions (QCDs) from IRAs will not be affected by the SECURE Act; accordingly, QCDs may still be taken from IRAs as early as age 70 1/2.

While the same life expectancy factors will continue to be used with no change under the SECURE Act, the IRS has recently (and separately) proposed to update the current life expectancy tables to adjust for longer expected lifespans. The IRS proposal has not yet been finalized, but is largely expected to be effective for RMDs calculated for 2021, and beyond.

Interestingly, for those who were born in the first half of the year (i.e., between January 1^st and June 30^th), the SECURE Act provides a longer delay of the first RMD than for those individuals born on July 1^st or later. Those with birthdates in the first six months of the year reach age 70 and 70 1/2 in the same year (and thus their first RMD is not required until two years later, when they reach age 72), whereas those whose birthdates are in the last six months of the year reach age 70 1/2 in the year they reach age 71 (and thus, their first RMD is ‘only’ delayed until the following year, when they turn 72).

The majority of retirees will not be impacted by the delayed RMD starting age (since most people aren’t able to afford to wait until the age when RMDs must begin), but for those that are, strategically timed Roth Conversions can be an effective tool to accelerate income in a tax-efficient manner, leveraging the additional time that IRA owners are afforded before their RMDs start, thus increasing their annual income.

Ultimately, the key point is that, while the change in RMD starting age won’t impact a large swath of the population, financial advisors are likely to have clients who will be affected by the change and who may benefit from the additional time in which Roth Conversions can be executed. Furthermore, advisors should also review their technology systems and planning processes, specifically for clients born after June 30, 1949 and who will be affected by the new RMD rules.

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When distributions are taken from tax-deferred retirement accounts, ordinary income taxes are due. However, sometimes funds may simply need to be moved from one retirement account to another – perhaps because an employee is retiring or switching jobs and chooses to move their 401(k) from their old employer to another 401(k), or to an IRA account, or because a client wishes to work with a new financial advisor and chooses to move all of their accounts over to the new advisor’s firm. Whatever the reason, there are specific rules for different types of money movement that financial advisors should understand to make sure their clients’ accounts are protected from unnecessary taxable distributions.

There are two categories of money movement between retirement accounts: Indirect and Direct transactions. For an Indirect Rollover, the account owner withdraws funds to be moved from the originating account and takes actual custody of the funds. The full amount of funds withdrawn must be deposited into the target account within 60 days. One caveat for Indirect Rollovers from employer-sponsored retirement plans is that there is generally a mandatory 20% withholding for Federal income taxes that the plan sponsor makes directly to the IRS, with the balance of the funds sent to the account owner. This means that, in order to avoid the tax withholding itself to be considered a taxable distribution from the account, the employee must ‘make up’ for the withheld amount by depositing funds from another source into the target account within the 60-day Indirect Rollover window. This withholding does not apply to IRA accounts, including IRA-based employer plans such as SIMPLE IRAs and SEP IRAs. Taxpayers are also limited to one Indirect Rollover between IRA or Roth IRA accounts every 365 days; any additional attempted Indirect Rollovers would be considered an account contribution and can potentially result in a 6% excess contribution penalty annually until corrected.

In addition to Indirect Rollovers, there are two types of Direct methods to move funds between accounts: Direct Rollovers and Direct Transfers. Direct Rollovers move funds between two retirement accounts, but unlike an Indirect Rollover, the funds are never in the account holder’s custody, nor is there any mandatory tax withholding. For Direct Rollovers, funds are moved from the trustee of one account directly to the trustee of the second account (where each account is a different type of accounts, e.g., 401(k) to IRA or vice versa). Direct Rollovers also have no time limit in which the transaction must take place, and there is no limit to how many Direct Rollovers can be done in a given year. While Direct Rollovers are not taxable events, they are reportable events and as such, are reported on Form 1099-R.

Similar to Direct Rollovers, Direct Transfers are made directly between the trustees of each account and don’t involve the account holder ever having custody of the funds being transferred. What distinguishes a Direct Transfer from a Direct Rollover, though, is that the accounts in a Transfer must be ‘like’ accounts (e.g., IRA to IRA, 401(k) to 401(k), etc.). Like Rollovers (including both Direct and Indirect), Like Rollovers, Transfers are not taxable events, but unlike rollovers, they are not reportable events and thus do not require submission of any forms to the IRS. Transfers are also different from Rollovers as they can accommodate funds designated as RMDs.

Ultimately, the key point is that each of the various ways funds can move between retirement accounts has its own distinct set of rules and requirements. Direct Rollovers are generally preferable over Indirect Rollovers, as they are subject to neither the 60-day time limit nor the 20% mandatory withholding, but do require to be reported to the IRS. On the other hand, Transfers do not need to be reported to the IRS and are used when an individual simply needs to change custodians or consolidate accounts involving the same kind of account.

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Sweeping legislative tax or retirement reforms typically happen only once every decade or so, but the final weeks of 2019 brought the second major piece of Congressional action in the past 24 months, as the SECURE Act (along with a series of year-end tax extenders), which was passed in the House this past summer, finally made its way through the Senate and was signed into law by the President. The legislation will have substantive repercussions as financial advisors help clients plan for their retirements for years to come.

In the context of financial advisors and the clients they serve, the first, and probably most notable change resulting from the SECURE Act, is the elimination of the so-called “stretch” provision for most (but not all) non-spouse beneficiaries of inherited IRAs and other retirement accounts. Under current law, non-spouse designated beneficiaries can take distributions over their life expectancy, but for many retirement account owners who pass away in 2020 and beyond, beneficiaries will have ‘only’ 10 years to empty the account. On the one hand, without any other distribution requirements within those 10 years, designated beneficiaries will have some flexibility around the timing of those distributions; however, certain types of “see-through” trusts that have been drafted to serve as beneficiaries of retirement accounts may find that they’re no longer able to make annual distributions to the trust under the new rules (only to suddenly have both the IRA and trust forcibly liquidated at the end of the 10-year window).

Other notable retirement planning changes under the SECURE Act include lifting the restriction on making contributions to a traditional IRA after age 70 ½ (as long as there is earned income to contribute in the first place), and an age increase for the onset of RMDs from age 70 ½ to age 72. However, as was the case with the IRS’s recent proposal to update the RMD life-expectancy tables, since only about 20% of retirees take no more than only the amount that they’re actually required to take, any changes in the rules around RMDs will have little effect on the remaining 80% who are already withdrawing more out of their accounts than the IRS requires. In addition, the SECURE Act does not change the age at which an individual can make a Qualified Charitable Distribution from their IRA, which remains at age 70 ½ and now creates a unique 1- or 2-year window where IRA distributions may qualify as charitable contributions, but not as RMDs (that haven’t yet begun).

Beyond the changing or elimination of various age-based thresholds for retirement accounts, the SECURE Act also includes an allowance for a penalty-free distribution up to $5,000 for a qualified birth or adoption, the creation of a Fiduciary Safe Harbor for selecting a “Lifetime Income Provider” (i.e., annuity company) for ERISA fiduciaries (thus assuaging at least some liability concerns around using lifetime income annuities in qualified plans), a substantial increase in the tax credit available to small businesses when establishing a retirement plan (as well as a brand new tax credit for small businesses that adopt an “auto-enroll” provision in their retirement plans), an increase in the allowable auto-enrollment “default” 401(k) plan contribution, improved access to employer plans for long-term part-time workers, and a significant reduction in the barriers to creating and maintaining Multiple Employer Retirement plans (which in theory will help to create economies of scale for lower plan costs when a group of small employers band together to provide a retirement plan)… as well as several other miscellaneous, smaller retirement provision changes.

Other notable non-retirement provisions attached to the SECURE Act include a repeal of the TCJA-introduced Kiddie Tax changes (reverting away from a requirement to use trust tax brackets and back to using the parents’ top marginal tax bracket), adjustments to the medical expense deduction threshold (back to 7.5%-of-AGI again for 2019 and 2020!), expanded provisions for 529 college savings plans to be used for Apprenticeships and (up-to-$10,000 of) student loan repayments, and a series of Tax Extenders for the mortgage insurance premium deduction and the higher education tuition and fees deduction.

Ultimately, the key point is that, although not nearly as sweeping as the Tax Cuts and Jobs Act of 2017, the SECURE Act of 2019 makes numerous updates to the rules around retirement plans in an effort to increase access to employer-sponsored retirement plans, and (hopefully) takes a positive step towards addressing the so-called retirement crisis. But as with other legislation in recent years, what legislation may give with one hand, it takes with the other, and in practice, many financial advisors may spend more time dealing with what is lost under the SECURE Act – in particular, the stretch IRA – than what is gained. At the very least, though, financial advisors will be busy in months ahead as they re-evaluate plans for clients impacted by the new and updated provisions introduced by the SECURE Act.

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Since as early as 1960, our national health expenditures have been steadily increasing. The American Medical Association found Americans paid nearly $3.5 trillion on healthcare in 2017, and expenses continue to rise, with estimated increases in healthcare expenses by the Bureau of Labor Statistics pegged at over 7% since 2016.

To address our country's rising healthcare expenses, the Medicare Modernization Act was signed into law by President George W. Bush in December, 2003.  This law created Health Savings Accounts (HSAs) to encourage individuals to enroll in High-Deductible Health Plans (HDHPs) in an effort to curb overall healthcare spending. In essence, HDHPs incentivize individuals to make healthcare decisions more carefully, with higher out-of-pocket requirements and lower premium expenses (which can often make up for the higher out-of-pocket requirements – especially for healthy individuals!).

Health Savings Accounts (HSAs) offer a further incentive for HDHP enrollment, as they provide a very attractive 'triple-tax' set of potential benefits. The three potential benefits are: 1) tax-deductible contributions, 2) tax-deferred growth, and 3) tax-free withdrawals for qualified medical expenses (although withdrawals made for non-qualified expenses are not tax-free and incur a 20% penalty if made before age 65). After age 65, though, non-qualified withdrawals have no penalty, so the account virtually becomes an “enhanced” IRA which can be used for any purpose but without the requirement of taking annual RMDs.

As with other tax-preferenced savings accounts, there are contribution limits for HSAs, which are based on the type of HDHP coverage an account owner has.  For family HDHPs, annual limits are $7,000 for 2019 ($7,100 for 2020), and for self-only HDHPs, limits are $3,500 for 2019 ($3,550 for 2020). Additionally, HSA owners age 55 and older are allowed to make an annual $1,000 catch-up contribution.

Financial advisors with clients who are married and have mixed health insurance coverage can help their clients understand their actual HSA contribution limits, as these limits depend on the type of plan each spouse has.  For spouses covered by separate self-only HDHP plans, each can contribute up to the maximum, self-only limit to their respective HSAs, but they can’t make up for any contribution shortfalls of the other spouse.

Sometimes, one spouse might have self-only HDHP coverage and the other an "employee-and-children" family HDHP (which does not offer coverage for the employee's spouse). This can be cost-effective for couples with children, as family HDHPs sometime provide for “employee and children” coverage that is less expensive than family plans that include both spouses. In this situation, the spouse with self-only coverage is limited to the self-only HSA contribution amount, and the spouse with family coverage can contribute up to the family limit.  But while the total between spouses cannot exceed the family limit, the spouse with the family plan can make up for any contribution shortfall of the spouse with self-only coverage.

In rare cases, both spouses may each opt for separate HSA-eligible family HDHPs through their employers (perhaps because of different in-network doctors offered by each plan). Again, the total contribution between spouses may not exceed the annual family limit, but in this situation, both spouses have the ability to compensate for any contribution shortfalls of the other, or to simply choose which spouse's HSA it makes sense to fund first.

Financial advisors who have married clients with HSAs, where at least one spouse is under age 65, can employ some strategies to maximize the value of their clients’ accounts.  For example, it may behoove the couple to maximize contributions to the older spouse’s account first in order to reduce the potential exposure to the 20% penalty for non-qualified withdrawals, since the penalty will not apply to the age 65+ older spouse. In addition, using HSA funds from the younger spouse’s account to pay for qualified medical expenses will also result in more funds in the older spouse’s account, available for penalty-free withdrawals for non-qualified expenses.

Ultimately, the key point is that the unique triple-tax benefits of HSAs make them attractive savings vehicles that can be used for expenses beyond medical care (but penalty-free for non-qualified expenses only after age 65). Financial advisors can help their clients with different HDHP coverage options get the most value out of their HSAs by guiding them through their specific contribution rules and choosing how to coordinate withdrawals for qualified and non-qualified expenses from each account in the most tax-efficient manner.

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Social Security spousal and survivor benefits were created to provide some level of Social Security benefits to households that relied primarily on a single worker, as a means to both financially support households with stay-at-home spouses, and to ensure that an earner’s widow was not left in poverty after the primary worker passed away. The caveat, however, is that in the early years of Social Security, some government workers had the opportunity to participate in jobs that did not pay into Social Security (so-called “non-covered” jobs), and instead directly received a private pension… with the end result that, in addition to their pensions, they also ended out receiving Social Security spousal and survivor benefits as though they were a stay-at-home spouse, when in reality they were simply a working spouse in a non-covered job.

To address this concern, Congress passed the Government Pension Offset (GPO) rule over 40 years ago to more fairly determine how Social Security benefits would be received by such non-covered government workers to ensure they were not effectively “double-dipping” into government pension benefits as workers and spousal and survivor benefits intended primarily for non-workers. Today, the GPO affects more than 695,000 Social Security beneficiaries.

The core of the GPO rule is that workers who receive pensions from government jobs that did not participate in Social Security will face a reduction of spousal and survivor benefits that they might otherwise be entitled to based on the work records of their spouses (who worked in covered jobs that did pay into Social Security).  Specifically, the GPO rule applies to individuals who meet three criteria: 1) worked at a federal, state or local government job where they did not pay Social Security taxes; 2) qualified for a pension from that job (that did not pay into Social Security); and 3) are eligible to receive spousal or survivor’s benefits from a spouse who did work in a job covered by Social Security.

For those who are affected, the GPO reduces spousal and survivor benefit amounts by 2/3 of the government pension benefit received from the non-covered employer. And if 2/3 of the retiree’s pension exceeded their spousal or survivor benefit altogether, the net result is that they will receive none of that Social Security benefit at all! Importantly, though, this rule applies only to the person who actually owns (i.e., originally earned) the non-covered pension. Which means that if a retiree inherits their spouse’s non-covered pension, their Social Security survivor benefits are not reduced because the pension was originally owned by and based on the work history of another.

In some cases, an individual may have pension benefits based on earnings from covered and non-covered employment (having switched jobs over the years between employers who both paid into the pension). In these situations, the GPO will reduce the individual’s benefits by 2/3 of the pension portion attributable only to non-covered employment. This non-covered pension portion is determined by multiplying the full amount of the pension benefit by the ratio of non-covered months of employment to the total months of employment contributing to the pension.

While the GPO is generally difficult to avoid, there are a couple of strategies that financial advisors can consider for their clients who may be impacted by the rule. The “Last-60-Months” exception says that the “GPO does not apply if an individual was covered by both the government retirement system and Social Security throughout his/her last 60 months of Federal, State, and local government service. The 60 months need not be consecutive.” Thus, if a worker leaves their current job under which they would have been subject to the GPO, finds new employment that is covered by Social Security and the government pension, and stays in that job (or another job that contributes to the government pension and that is covered by Social Security) for at least 60 months of service prior to retirement, the GPO rule would not affect their Social Security spousal or survivor benefit.

Alternatively, a government employee has the option of withdrawing from their pension altogether. For this strategy to avoid the GPO, the worker would need to withdraw all of their own contributions (with interest) from the plan, forfeiting any employer contributions (unlike most non-government pensions, many government pensions consist of both employee and employer contributions). This strategy should be considered carefully, as while the GPO impact on Social Security benefits would potentially be eliminated, so too would any pension benefits to which the individual was once entitled (and the loss of the pension itself may easily end out costing more than the otherwise foregone Social Security benefits would have been in the first place!).

Ultimately, the key point is that advisors should be aware of when and how the Government Pension Offset may affect their clients, and if their clients can use a strategy to mitigate the GPO’s impact on their benefits. While there are stirrings of legislative proposals to eliminate the GPO rule (along with the WEP), the population actually affected by these rules is relatively small (approximately 1% of all Social Security beneficiaries in 2018 were affected by the GPO). Thus, traction on any amendments to eliminate or modify these rules may be difficult, especially since there arguably are good policy reasons for it to exist (to avoid the implicit ‘double dipping’ of earning a non-covered pension as a worker and a spousal or survivor benefit nominally intended for non-working spouses). In the meantime, advisors can help their clients by understanding when the GPO needs to be factored into a client’s financial plan, especially given that the GPO can heavily (or fully) eliminate Social Security spousal or survivor benefits that they might have otherwise anticipated receiving!

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In the midst of America’s Great Depression (which spanned from the October 1929 “Black Tuesday” stock market crash to the end of the 1930’s), President Franklin D. Roosevelt enacted several “New Deal” programs to provide the country with relief (and to encourage recovery) from the poverty and high rates of unemployment facing Americans at the time. Social Security was (and remains) one of the most significant programs created as part of the New Deal, and was intended to protect Americans from the “hazards and vicissitudes of life”, offering them “general welfare” and “social insurance” through retirement income for those over age 65.

However, Social Security benefits were not initially available for state or local government employees because the institutions they worked for often managed their own retirement (pension) programs for employees. To address the concern that state/local government employees were ‘missing out’ on Social Security, and in part to allow states to shift a portion of the retirement burden to the Federal government, Congress passed Section 218 of the Social Security Act in 1951, providing Social Security benefits to public employees in states that entered into a voluntary (but irrevocable) agreement with the Social Security Administration to coordinate state/Federal government benefits.

But the original Social Security retirement benefit formula did not account for workers who had retirement income from both their pension plans through “non-covered” employers (i.e., state or local government employers who did not pay into Social Security), and Social Security benefits through employers who did pay into Social Security. Which was problematic, because Social Security is designed to provide higher replacement rates for lower income workers, but couldn’t distinguish between those who actually had a lifetime of low income, and those who had high lifetime earnings but whose income from “non-covered” state or local government jobs (with its own pension instead) was excluded from the Social Security benefit calculation. Accordingly, policymakers felt that these workers eligible for both Social Security and a non-covered pension benefit were being awarded a higher Social Security replacement rate than they should have been. Thus, in 1983, Congress established the Windfall Elimination Provision (WEP) to more fairly adjust the Social Security benefit for these “non-covered” workers who appeared, based only on their Social-Security-covered earnings, to be lower-income than they actually had been in their working years.

While the number of workers in the United States who are subject to the WEP is relatively small,  it’s becoming more common for advisors to run across clients who are affected by WEP as a greater number of public sector employees who started their careers in non-covered jobs are now approaching retirement.

Fortunately, while the WEP can significantly alter an individual’s total retirement income, there are several strategies that an advisor can employ to minimize that impact, including increasing the number of years with “substantial” earnings from a “covered” employer, or taking a lump-sum distribution of a non-covered pension before becoming eligible for the benefit (thus reducing the length of time the WEP penalty is applied to the Social Security benefit).

Ultimately, the key point is that advisors should be aware of the circumstances under which the Windfall Elimination Provision applies to a retiree’s benefits, and the various rules around how their client’s total retirement benefit (as well as any family/auxiliary Social Security benefits based on the client’s own record) may be impacted by the WEP.  At a minimum, it’s crucial to be aware of the WEP to ensure that assumed Social Security benefits are adjusted properly for planning purposes (especially since the WEP adjustment is typically not reflected on the worker’s Social Security statement). And while not all of the WEP penalty can always be unwound even with proactive planning (as might be the case for someone who had a non-covered position early in their career), at the very least, there are a few strategies that advisors have at their disposal to help reduce its overall impact.

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After several years of speculation and more than a year since the President issued an Executive Order on “Strengthening Retirement Security in America”, the IRS has released its proposal to update the life expectancy tables used to calculate the annual Required Minimum Distributions (RMDs) from all sorts of tax-preferenced accounts, including IRAs and 401(k)s, for both lifetime account owners and their (stretch) beneficiaries. Most notably, this is the first time the tables have been updated since 2002, despite the fact that life expectancy has increased more than 2% (or 1.6 years) for all Americans, and more than 8% for Americans who have reached the age of 65!

Central to the proposal (which must still go through the formal approval process and thus might not “go live” until sometime next year, though the proposed changes wouldn’t take effect until 2021 anyway) are updates to the RMD factors used to calculate required minimum distributions themselves in each of the three different life expectancy tables, including the Uniform Lifetime Table (for retirement account owners to calculate their RMDs during their lives), the Joint Life And Last Survivor Expectancy Table (used by account owners who have named a spousal beneficiary who is more than 10 years younger), and the Single Life Expectancy Table (which is used by beneficiaries of inherited retirement accounts to calculate their so-called “stretch” distributions).

However, while lowering RMDs across the board will result in some increased tax deferral benefits, the changes likely won’t have as much of an impact for retirement account owners and beneficiaries as was likely hoped for. Specifically, according to data provided by the IRS, of the Americans who are required to take distributions from retirement accounts, only roughly 20% are taking no more than the minimum required. Which means that the remaining 80% are taking more than the required minimum, thus making any decreases in RMDs a moot point.

The question then becomes, will lowering RMDs for those 20% (who likely already have enough wealth to meet their retirement needs in the first place) have a material impact on their account balances as they age? For account owners and beneficiaries who have been extremely fortunate with their returns over the years and have much-larger-than-typical account balances, perhaps. However, when considering someone with an IRA valued at $1 million, the first year RMD would only decrease by roughly $2,100, and only a portion of that amount would have been due as taxes; the value of deferring that tax liability is only the growth potential on those taxes… which are hardly amounts that could significantly alter someone’s overall financial picture later in life (especially for already-affluent retirees), even when considering that the RMD factors continue to increase through the years.

And that lack of impact stretches even to those who have much longer life expectancies, such as younger individuals who have inherited a retirement account and use the Single Life Expectancy Table. A 40-year-old, for example, would see only a tenth of a percentage point decrease in the required distribution amount in the first year, which won’t be a very material difference, even for those who rely on that extra income from an inherited retirement account.

Notably, though, individuals taking RMDs will need to consider the transition to the new life expectancy tables if/when they take effect in 2021. Which, for lifetime RMDs for existing retirement account owners, is fairly straightforward – to simply use the new table in 2021 – though those who defer their first age 70 ½ RMD from 2020 into 2021 must still use the ‘old’ tables for the 2020 RMD. In the case of beneficiaries of inherited retirement accounts looking to stretch, the transition process is a bit more confusing, as such beneficiaries cannot simply use the new life expectancy tables going forward at their current age. Instead, they must retroactively determine what their ‘original’ stretch period would have been in the past under the new tables, and then adjust forward to where that distribution schedule would be today (by subtracting 1 for each subsequent year since the year after the original account owner’s death).

Ultimately, the key point is that, while updates to the life expectancy tables have been a long time coming (especially since other tables – like those used by the IRS to analyze life insurance contracts – have already been updated to reflect longer lifespans years ago), the proposed changes simply won’t make much of a difference for the vast majority of retirement account holders and beneficiaries. Still, for those who take ‘only’ the minimum required by the IRS, the decreases might not provide that much of a benefit, but at least it does help to defer some taxes, which is hardly ever bad news.

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