What You Need to Know About the Required Minimum Distribution (RMD) Formula Changes in 2022

As a result of the increased life expectancy, retirees can now retain their tax-deferred funds in their retirement accounts longer. The current Internal Revenue Service (IRS) tables now feature higher life expectancy factors, lowering the mandatory minimum annual withdrawal. 

In this article, you will learn:

• WHAT IS A REQUIRED MINIMUM DISTRIBUTION (RMD)?
• WHAT ACCOUNTS REQUIRE RMDs?
• WHEN MUST I START TAKING REQUIRED MINIMUM DISTRIBUTIONS?
• HOW IS A RMD CALCULATED?
• CHANGE IN RMD TABLES FOR 2022
• WAYS TO WITHDRAWAL RETIREMENT ASSETS

WHAT IS A REQUIRED MINIMUM DISTRIBUTION (RMD)?

Saving for retirement in tax-deferred accounts is the most common way to save for retirement today.  These accounts allow account holders to postpone paying taxes until a later date. Some examples of tax deferred accounts include 401(k)s, traditional IRAs, and 403(b)s.  

However, you cannot defer the taxes on your accounts indefinitely. The IRS expects you to start distributing money out of the accounts at some point in your life and thus start paying taxes on your savings.  The required minimum distribution rule was created by the IRS to force people to make minimum distributions out of their accounts.  

The consequences for not taking RMDs is very high.  If you do not take a required minimum distribution or if you don’t take a high enough minimum distribution (you are always free to take an amount higher than your requirement) then you could be required to pay a 50% excise tax on the amount not distributed as required.

It is important to note that this article does not go over RMDs that may be required when you inherit a retirement account.  There are special rules and requirements that vary depending on the details of the parties involved.

WHAT ACCOUNTS REQUIRE RMDS?

The RMD rule applies to many retirement savings plans. Applicable retirement savings plans include:

• 401(k) plans – Company-sponsored retirement account that allows employees and employers to make contributions
• Traditional IRAs – Individual retirement accounts where you can make full or partial tax-deductible contributions. 
• Savings Incentive Match Plan for Employees (SIMPLE) IRAs – Set up by the employer and allows employees to make voluntary salary deductions, and the employer can then make non-elective or matching contributions
• SEP (Simplified Employee Pension) IRAs – Pension plan set up by the employer who makes contributions on behalf of the employee
• 403(b) plans (tax-sheltered annuity – TSA) – Retirement plan for public schools and tax-exempt organizations. Both employees and their employers can contribute to the account.
• Profit-sharing plans – Retirement plan that allows discretionary employee and employer contributions.
• 457(b) plans – Retirement plan for certain local and state governments and tax-exempt non-governmental entities
• Other defined contribution plans

WHEN MUST I START TAKING REQUIRED MINIMUM DISTRIBUTIONS?

In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law by the President of the United States. Part of this act changed the age for when retirees must start taking required minimum distributions from their tax deferred retirement accounts.  Prior to this act, retirees had to begin taking minimum distributions at 70 ½. Now, you do not have to take withdrawals until your reach age 72, as long as your 70th birthday is July 1, 2019 or later.

HOW IS A RMD CALCULATED?

Your RMD is calculated yearly.  It is based on your age and the values of applicable accounts as of December 31st of the previous year.  To find your required minimum distribution in a particular year, you take the sum of previous year's balances on applicable retirement accounts as of December 31 and divide it by the life expectancy factor corresponding to your age as indicated on the table related to your situation. 

There are different life expectancy factor tables depending on a person’s situation:

• Joint and last survivor table – Applicable if a spouse is the sole beneficiary of the account and is more than 10 years younger than the account owner spouse
• Single life expectancy table – Used to calculate RMDs for “eligible designated beneficiaries”
• Uniform lifetime table – for all unmarried IRA owners calculating their own withdrawals, married owners whose spouses aren’t more than 10 years younger, and married owners whose spouses aren’t the sole beneficiaries of their IRAs

For instance, if you turn 72 and your account balance at the end of the year is $500,000, using the uniform lifetime table, your required minimum distribution should be $500,000/27.4, which is $18,248. 

CHANGE IN RMD TABLES FOR 2022

The IRS updated their Uniform Lifetime Table in 2021 for the trend toward longer lifespans. This caused the RMD tables to be adjusted as well. This adjustment reduced the amount required to be taken out each year compared to the prior iteration of the table.

There are various benefits of receiving a lower RMD, including:

• Having a constant income for more years
• Deferring taxes a little longer
• Decreasing your taxable income, which increases the possibility of qualifying for a lower tax bracket

WAYS TO WITHDRAW RETIREMENT ASSETS

Many retirees need to start withdrawing funds years before thinking about their RMD.  It is important to have a set plan in place for making withdrawals throughout retirement.  You want to balance not running out of money with not leaving a mountain of unspent money at death.  Here are some of the methods used to withdrawal money in retirement.

4% RULE

The 4% rule is a strategy that suggests withdrawing 4% of your retirement funds each year. According to William Bengen, the originator of the rule, by following that withdrawal strategy the funds can sustain you for 30 years.

Some critics argue that the money might not last you that long due to market volatility, and some suggest more modest spending as low as 2% of your funds. Regardless of the situation, having some form of planned spending can go a long way in safeguarding your retirement funds from running out too quickly.

TOTAL RETURN STRATEGY

The total return strategy seeks to maximize the growth of the account. Ideally, you withdraw funds for use in the short-term (3 to 12 months) and leave the rest invested.  With the total return approach, investments aren’t selected solely on their yield. The idea is that it shouldn’t matter if future retirement distributions come from investment income or capital gains.

BUCKET STRATEGY

With the bucket strategy, you split your money into three buckets. There are many ways to use this method in terms of the amounts to put in each bucket and the timeframe each bucket represents. A basic explanation is that bucket one should hold the funds you need in the short term – 6-12 months, which you can invest in highly liquid assets. Bucket two should hold the money you need in interim such as 1-3 years and should be invested conservative assets like bonds. Lastly, bucket three should hold assets you won't need for at least 3 years, which you can be invested in higher growth assets like stocks. 

FIXED-DOLLAR STRATEGY 

Alternatively, you may adopt the fixed-dollar strategy, whereby you set a fixed annual withdrawal amount. Then you can revise it downwards or upwards after a few years, depending on how your portfolio is performing. If your portfolio becomes profitable, you may increase your withdrawal and vice versa.

RETIREMENT GUARDRAILS

Guyton’s retirement guardrail strategy of withdrawals adjusts the withdrawal percentage yearly according to account values at the end of the year and inflation. This method requires a withdrawal rate within the guardrails.  The guardrails are a higher lower account value. If your account value is above the upper guardrail, then your portfolio can handle an increase in distributions and your guardrails can be reset with a higher maximum distribution. If you account value is below the lower guardrail, then your guardrails and the maximum recommended withdrawal will need to be reset lower.

AVOID THE RISK OF OUTLIVING YOUR MONEY

The changes in the RMD formula are a welcome relief for retirees as it allows them to spread more of their assets over an extended period. Deferring more money is an excellent way of saving on taxes and an opportunity for your portfolio to grow more. 

However, due increased life expectancy, medical advances, and inflation, the risk of outliving your retirement funds is always present. For these reasons, planning for your retirement is always essential. 

DO NOT TAKE CHANCES WITH YOUR RETIREMENT PLANNING- LET US HELP YOU PLAN STRATEGICALLY

At Gudorf Financial Group  we walk our clients through the process of navigating their retirement. 

Our team can assist with:

• Retirement Planning
• Investment Management
• Tax Planning
• Retirement Income and Withdrawal Strategies
• Social Security and Medicare
• Estate Planning

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