Mark Miller: Remaking Retirement

Should RMD Rules Be Reformed?

Mark Miller

Tax-deferred retirement saving isn't forever. At age 70 1/2, you must start withdrawing funds from 401(k) and IRA accounts. Yet many retirees find the required minimum distribution rules burdensome, and surprisingly large numbers would prefer not to draw down funds at all.

Ideas have been rattling around for a while now to reform the RMD rules, and President Donald Trump signed an executive order on retirement policy in August that included a call to review the formulas used to determine RMD amounts. Meanwhile, the latest tax cut proposal from House GOP leadership (aka Tax Reform 2.0) calls for repeal of RMDs on accounts with $50,000 or less.

What's this all about?

First, a refresher: When you reach age 70 1/2, a certain amount of your tax-deferred savings in IRAs and most 401(k) accounts must be drawn down every year under the RMD rules. Income taxes must be paid on the withdrawn funds. RMDs also can trigger additional taxes on Social Security income, and even high income Medicare premium surcharges. Missing an RMD leaves you on the hook for an onerous 50% tax penalty, plus interest, on the amounts you failed to draw on time.

The executive order directs the U.S. Treasury to consider whether the tables that determine RMD amounts should be revised in light of rising longevity. The life expectancy tables were last revised in 2002; average life expectancy for men at age 70 has risen 2.1 years since 2000 and 1.6 years for women, according to the Society of Actuaries. That means any revisions likely would have a very small impact on the amounts average retirees must withdraw--no more than a few hundred dollars annually, in most cases.

"It's not going to be very meaningful unless it's a mega-IRA," says Ed Slott, an author and retirement expert who is one of the nation's leading authorities on individual retirement accounts.

Howard Gleckman of the Tax Policy Center notes that the revisions would mainly impact wealthier households, since nearly half of American retirees say they have less than $100,000 in retirement savings. Gleckman calculated the likely tax savings for average households--and came up with a whopping $27.60.

But tax savings may not really be the key point here. If there is a benefit to this idea, it could be allowing retirees to hang on to invested funds longer to meet emergency spending needs. Indeed, some research suggests that many retirees retain surprisingly high percentages of their savings well into retirement.

The Employee Benefit Research Institute reported this year that within the first 18 years of retirement, individuals who had accumulated less than $200,000 in nonhousing assets before retirement had spent down (at the median) about one quarter of their assets. The drawdown pattern was similar for retirees with assets between $200,000 and $500,000, and only 12% for those with $500,000 or more in assets.

The study pointed to annuity income from defined benefit pensions and Social Security as key reasons for this; retirees tend to simply adjust their spending where they can to match what is coming in and hang on to savings to meet emergency needs. By contrast, retirees without defined benefit pensions saw their median nonhousing assets fall by 34% over those first 18 years of retirement.

A 2016 Vanguard study looked at withdrawals from all financial accounts among wealthier households. It found that among wealthier households, the median withdrawal rate from financial accounts over a one-year period was a modest 3%. As a share of retirement income, saving drawdowns varied from 17% among households with defined benefit pensions and high Social Security benefits to 39% for households more reliant on savings (that is, without defined benefit pensions),

Many savers prefer to hang on to their account balances in case of an emergency spending need.

"For many, it's a self-insurance policy," says Keith Bernhardt, vice president of retirement income at Fidelity Investments. "People want to make sure they have something set aside in case something bad happens. They don't want to run out or be a burden on their children or friends."

Of course, the data on asset preservation described in these studies are no guarantee that the same drawdown patterns will persist in the future.

Defined benefit pensions are disappearing rapidly in the private sector. And Social Security benefits are becoming less valuable over time, due mainly to the gradual increase in the age when full retirement benefits are available, which was set in motion in reforms enacted in 1983. That serves, effectively, as a benefit cut by raising the bar on what it takes to get a full benefit--retiring at age 67, for example, earns a lower delayed retirement credit than it did when the full retirement age was 65.

Some proposals for reform of RMDs would go further than reviewing the longevity assumptions, as per the executive order. The House Republican Tax Reform 2.0 package called for elimination of RMDs from accounts with $50,000 or less. The bill's chances to become law before the midterm elections seem slim. (In 2015, the Obama administration made a similar proposal, calling for elimination on RMDs in accounts up to $100,000.)

Slott has called for eliminating RMDs altogether or boosting the age when they kick in dramatically to age 80.

"Age 70 1/2 is far too young to force people to start taking withdrawals from IRAs and 401(k)s," he says, noting the growing number of older Americans who continue to work past traditional retirement age and into their 70s. (Under the current rules, workers can postpone withdrawals from a current employer's retirement plan, but not from IRAs or plans sponsored by former employers.)

Bernhardt agrees that a higher age makes sense, although Fidelity has no formal position on just what the age should be.

"What I'd really like to at least do is get rid of the '.5,'" he says. "The 70 1/2 age causes a lot of confusion, especially for people born in June or July. We should just make it the year that you turn a certain age."

The IRS uses the longevity assumptions to determine a distribution factor. If you're curious about how the current assumptions work, see IRS Publication 590-B--scroll down to Appendix B (Uniform Lifetime Table). Divide your account balance by the "distribution period" to determine what you must draw down in any given year.

Helpfully, the IRS calculates these factors all the way to age 115!

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to WealthManagement.com and the AARP magazine. He publishes a weekly newsletter on news and trends in the field at //retirementrevised.com/enewsletter/. The views expressed in this column do not necessarily reflect the views of Morningstar.com.