Abstract
Required minimum distributions (RMDs) are an important part of individual requirement accounts and defined-contribution retirement plans including 401(k), 403(b) and 457(b) plans. Such plans are intended to provide retirement income for the account owner and his or her spouse. They are not intended to pass untaxed wealth on to the next generation. RMDs do that by requiring that a portion of the balance in an account is distributed (and taxed) each year beginning by age 70½ (recently extended to age 72). This article examines the origins and extensions of RMDs, how they are calculated and how they work. It then assesses the recently enacted SECURE Act and the proposed updated Internal Revenue Service tables of the life-expectancy factors used to calculate the amount of the annual RMDs.
Keywords
Required Minimum Distributions from IRAs and DC Retirement Plans
This article examines required minimum distributions (RMDs) from individual requirement accounts (IRAs) and qualified defined-contribution (DC) retirement plans under Internal Revenue Code (IRC) Section 401(a)(9). It will first examine the current RMD rules and how they function and then evaluate the recent changes to those rules made by the SECURE Act, signed into law on December 20, 2019. Many of its provisions took effect almost immediately on January 1, 2020. It will then examine and evaluate the proposed Life Expectancy and Distribution Tables likely to take effect on January 1, 2021.
Individual Retirement Accounts
Individual Retirement Accounts were created by the Employment Retirement Income Security Act of 1974 (Pub. L. 93-406; ERISA). However, a precursor may be found in the Self-Employed Individual Retirement Act of 1962 (Pub. L. 87-792; SEIRA), also commonly known as the Keogh Bill or H.R. 10. 1
Section 401(a)(9) of the IRC first applied to Keogh plans and was then extended to IRAs and to other defined-contribution retirement plans by the Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248; TEFRA). TEFRA required the distribution of the entire account balance in the tax year the participant attained age 70½ or over the remaining life expectancy of the participant and his or her spouse. 2
IRAs have two primary purposes: (1) to provide a tax-favored retirement savings plan for employees not covered by an employer-sponsored defined-benefit (DB) pension plan and (2) to preserve the tax-deferred status of retirement assets rolled over from other tax-deferred retirement arrangements.
Required Minimum Distributions
The ERISA also created RMDs to force individuals with tax-deferred assets in IRAs and DC plans to take timely withdraws so that they could be taxed as ordinary income. If it were not for RMDs, well-off taxpayers could sit on their retirement assets in IRAs and DC retirement plans for the rest of their lives and then pass them on to their heirs, still untaxed.
What are now called “traditional IRAs” are funded by tax-deductible contributions of the employees and from rolled-over assets from other tax-deferred DC plans. Thus, contributions to traditional IRAs and qualified DC plans are made with pre-tax dollars. The amount of the annual contribution is deducted from the employee’s adjusted gross income (AGI). Taxes on the contribution and the earnings on those funds (invested assets) are deferred until withdrawn, at which time they are taxed as ordinary income.
If withdrawn before the age of 59½, the amount withdrawn may be subject to an additional 10% early-withdrawal penalty (excise tax). However, under Section 72(t) of the IRC, the early-withdrawal penalty can be avoided if such distributions are made on substantially equal periodic basis and not subsequently modified. 3
Extension of RMDs to Other Plans
In addition to traditional IRAs, the RMD rules were extended to other retirement savings plans. They include Section 401(k) plans, available mainly to the private sector employers since 1981; 403(b) plans, available to public education employers (mainly teachers) and certain 501(c)(3) tax-exempt organizations, since 1958; 457(b) plans available to state and local governments and tax-exempt organizations since 1978 (although an earlier version was available to municipal employees). RMDs have also been required for Simplified Employee Pensions (SEP)-IRAs since 1978, Salary Reduction Simplified Employee Pensions (SARSEP)-IRAs since 1986, Savings Investment Match Plans for Employees (SIMPLE)-IRAs since 1996 and the federal government’s Thrift Saving Plan since 1986.
RMDs are not required for Roth IRAs, available since 1997. They are funded by employee after-tax contributions. Since the contributions have already been taxed, there is no need to require their timely withdrawal. However, once the original owner of a Roth IRA dies and the account is inherited by a non-spouse beneficiary (or beneficiaries), it becomes subject to RMDs. 4
Growth of Traditional and Roth IRAs
Most of the growth in traditional IRAs since 2000 has resulted from rollovers from other DC retirement plans, especially 401(k)s. In contrast, the growth in Roth IRAs is the result of after-tax employee contributions. When a taxpayer rolls money from a tax-deferred retirement plan to a Roth IRA, he or she must pay income taxes on those funds in that year. Not only is that often prohibitive, but it will likely push the account owner into a higher tax bracket.
Table 1 reports the number and the percent of households with different types of IRAs from 2000 through 2019. However, beginning 2014, the Investment Company Institute (ICI) changed its sampling methodology (from telephone interviews to participant written responses), which resulted in a significant reduction the number of reported households with IRAs. Accordingly, this discussion will focus on the period 2015 to 2019.
U.S. Households Owning Individual Requirement Accounts (IRAs), Selected Years, 2000 to 2019.
aEmployer-sponsored IRAs include SEP-IRAs, SARSEP-IRAs and SIMPLE-IRAs.
b Beginning 2014, the ICI changed its sampling methodology resulting in significantly lower numbers of IRA ownership reported.
Source. Investment Company Institute. Appendix tables to “The role of IRAs in U.S. households’ saving for retirement, 2019 (2019, December). ICI Research Perspective, Vol. 25, No. 10. Figure A1. Retrieved from https://ici.org/pdf/per25-10.pdf.
During that 5-year period the number of households owning any type of IRA grew from 40.2 million (32.3% of all U.S. households) to 46.4 million (36.1%). During the same period, the number of households with traditional IRAs grew from 30.4 million (24.4%) to 36.1 million (28.1%). Traditional IRAs are the most common due largely to rollover contributions from other types of DC plans.
In contrast, Roth IRAs have grown mainly by after-tax contributions. In 2015, there were 20.3 million households with Roth IRAs (16.3% of households). By 2019 that number had increased to 24.9 million (19.4%).
Employer-Sponsored IRAs
Traditional IRAs and Roth IRAs are opened and funded by employees and by rollover from DC retirement plans. SEP-IRAs, SARSEP-IRAs and SIMPLE-IRAs are sponsored by employers. I could find no data on the number of households owning each of these types of plans. However, the ICI provides combined data for “employer sponsored” IRAs. In 2015, 6.7 million households had employer-sponsored IRAs (5.4%). By 2019 that number has jumped to 7.8 million (6.1%).
As indicated in Table 2, 401(k) plans are by far the largest of the DC plans. In 2018, they accounted for $5.2 trillion of the total of $7.5 trillion in total DC plan assets (69.3%). In contrast, 403(b)s and 457(b)s held $0.9 trillion (12%) each and all other private-sector DC plans $0.5 trillion (6.7%).
Defined-Contribution Plan Assets by Type of Plan, Selected Years, 1995 to 2018 ($ Trillions).
Note. TSP = Thrift saving plan; DC = defined contribution.
a Includes Keogh and other private sector DC plans (profit-sharing, stock bonus and money purchase) plans without 401(k) features.
b Calculated by author.
Source. 2019 investment company fact book: A review of trends and activities in the investment company industry. Figure 8.10, p. 164. Retrieved from https://www.ici.org/pdf/2019_factbook.pdf.
How RMDs Work
Until recently, withdrawals from IRAs and DC retirement plans had to begin by age 70½ or upon retirement if the account owner is still working. Effective January 1, 2020, the age requirement was changed from 70½ to 72 (discussed below).
The minimum amount of the required withdrawal is calculated by dividing the account balance (asset value) as of December 31 of the immediately preceding calendar year by the account owner’s “life expectancy factor” (also known as the RMD factor or distribution period).
The IRS publishes three tables reporting the life-expectancy factors used to calculate RMDs. 5 One is the Uniform Lifetime Table that applies to unmarried owners, married owners whose spouse is not more than 10 years younger and married owners whose spouse is not the sole beneficiary of the owner. This is the most often-used table. The second is the Joint and Last Survivor Expectancy Table, which applies to account owners whose spouse is more than 10 years younger and is the sole beneficiary of the IRA. The third is the Single Life Expectancy Table. It applies to beneficiaries of inherited accounts.
How these three tables apply depends on the relationship of the beneficiary to the account owner.
Account Owner
To calculate the RMD when the account owner is alive, divide the retirement-account balance as of December 31 of the previous calendar year by the life expectancy factor (age-specific life expectancy) of the owner. Until recently, the first RMD had to be taken by April 1 of the year after turning 70½ and the second RMD by December 31 of the same year. It is usually a good idea to take the first RMD before December 31 of the first year. That avoids taking two RMDs in the same tax year and possibly pushing the account owner into a higher tax bracket. 6
Table 3 displays the RMD for a hypothetical account balance of $100,000 for selected ages 70 to 115. Note the inverse relationship. As remaining life expectancy decreases, the RMD increases.
Current and Proposed Uniform Lifetime Table for Selected Ages 115/120 and RMDs per $100,000 in Assets.
Note. RMD = required minimum distribution.
Source. Internal Revenue Service. Publication 590-B (2018), Distributions from individual retirement arrangements (IRAs). Appendix B and Updated life expectancy and distribution period tables used for purposes of determining minimum required. Retrieved from https://www.irs.gov/publications/p590b and https://www.federalregister.gov, respectively.
Tables 3, 4 and 5 report data for the current (2020 and earlier) and the proposed (effective 2021) years. The latter will be discussed below.
When an owner dies, the RMD of the beneficiary in the first year is the same as what the owner would have received. For years after that, it depends on who or what the beneficiary is.
Spouse Less Than 10 Years Younger
If a spouse is less than 10 years younger than the account owner, he or she may either (1) treat the account as his or her own and continue to use the life expectancy from the Uniform Lifetime Table (Table 3), (2) base RMDs on his or her own life expectancy from the Joint and Last Survivor Table (Table 4), (3) base RMDs on the decedent’s age at death and reducing it by one year for each year thereafter or (4) if the original account owner died before starting withdrawals, withdraw the entire balance by the end of the fifth year after the owner’s death.
Current and Proposed Joint and Last Survivor Table for Owner Age 70 and Spouse 10 or More Years Younger.
Note. RMD = required minimum distribution.
Source. Internal Revenue Service. Publication 590-B (2018), Distributions from individual retirement arrangements (IRAs). Appendix B and Updated life expectancy and distribution period tables used for purposes of determining minimum required. Retrieved from https://www.irs.gov/publications/p590b and https://www.federalregister.gov, respectively.
Spouse More Than 10 Years Younger
If the account owner’s spousal beneficiary is more than 10 years younger than the deceased original account owner and is the sole beneficiary, the Joint Life and Last Survivor Expectancy Table is used. It is a lengthy and complex table as it reports the life-expectancy factors of both the decedent (vertically) and the beneficiary for different ages for the younger spouse (horizontally). Table 4 presents an example for an account owner age 70 and a spouse ages 50 through 59 for both the current and proposed tables.
Non-Spouse Beneficiaries
Individual beneficiaries, other than the spouse, can (1) withdraw the entire balance by the 5th year following the owner’s death, (2) calculate the RMDs using the Single Life Table (Table 5), (3) if the owner died after starting withdrawals (a) use the longer of the beneficiary’s life expectancy determined in the year following the owner’s death reduced by one year for each subsequent year, or (b) use the original owner’s remaining life expectancy at death reduced by one year each subsequent year or (4) if the owner died before starting RMDs, the beneficiary’s age at the end of the year following the owner’s death reduced by one year in each subsequent year.
Life Expectancy Factor for Selected Ages 0 to 110 and RMD per $100,000 in Assets (IRS Table 1).
Note. RMD = required minimum distribution; IRA = individual requirement account.
Source. Internal Revenue Service. Publication 590-B (2018), Distributions from individual retirement arrangements (IRAs). Appendix B and Updated life expectancy and distribution period tables used for purposes of determining minimum required. Retrieved from https://www.irs.gov/publications/p590b and https://www.federalregister.gov, respectively.
Table 5 displays the single life-expectancy factor and RMD per $100,000 of balance for ages 0 to 111+ for the current table and 120+ and the proposed tables.
Institutional Beneficiaries
If the beneficiary is an estate, trust, charity or some other nonperson entity, the RMDs are based on the age of the original owner upon death. If the original owner was alive on April 1 after reaching age 70½ (72 beginning January 1, 2020), RMDs are calculated based on the life expectancy of the original owner using the less generous (in terms of postponing withdrawals) requirements of the Single Life Expectancy Table (Table 5).
Comparisons
Under the current Uniform Lifetime Table, the life-expectancy factor for a 70-year-old is 27.4. On a $100,000 balance that would result in an RMD of $3,650 (Table 3). In contrast, the current Single Life Expectancy Table has a life-expectancy factor at age 70 of 17.0. That results in an RMD of $5,882. That is $2,232 or 61% more (Table 5). Thus, under the Single Life Expectancy Table, the assets in the account will be withdrawn (and taxed) much faster than under the Uniform Life Table.
Under the proposed table likely to become effective January 1, 2021, an 80-year-old account owner would have a life-expectancy factor of 20.2, which would result in an annual RMD of $4,950 per $100,000 of balance (assets). That is $398 less than the currently required (Table 3). Similarly, under the proposed updated table, for an 80-year-old account owner the life-expectancy factor would be 11.2 and the RMD per $100,000 of balance would be $8,929 (Table 5). That is $875 less than the current table.
If the owner died before reaching age 70½ (now age 72), the entire balance must be withdrawn by December 31 of the fifth year following the death. 7
Multiple Retirement Accounts
It is not unusual for an individual to own two or more traditional IRAs and/or DC retirement plans because of having had multiple employers due to job change, inheritance, moonlighting or a divorce settlement. That can complicate things.
If the individual has multiple IRAs, the RMDs must be calculated separately for each IRA. But, the RMD amount may be withdrawn from any one or more IRAs accounts. Similarly, multiple 403(b) plans must be calculated separately but the total RMD amount can be taken from one or more of the $403(b) plans. However, for other types of DC retirement accounts, including 401(k)s, 457(b)s, SEP-IRA, SARSEP-IRA and SIMPLE-IRA, the RMDs must be calculated separately for each plan and taken separately from that plan. 8
Withdrawal Activity
As indicated in Table 6, most of the withdrawal activity from traditional IRAs is the result of RMDs. Such withdrawals were taken by 77% of households owning IRAs in 2019. That is up from 61% in 2015 and 60% in 2008. Recall that there is a discontinuity in these data. Beginning 2014, the Investment Company Institute’s IRA Owners Survey change its methodology from a telephone survey to a self-administered online survey. The result was a marked increase in the number of households reporting RMD-based withdrawals and a reduction in the reported need-based withdrawals. The latter declined from 14% in 2016 and 23% in 2008 to 12% in 2019. The withdrawals based on a regular dollar amount are the result of Section 72(t) withdrawals mentioned above.
Reasons for Withdrawals From Traditional IRAs, 2008 to 2019 (Percent of Traditional IRA-Owning Households).
Note. IRA = individual requirement account; RMD = required minimum distribution.
a Beginning 2014, the ICI changed its sampling methodology resulting in significantly lower numbers of IRA ownership reported.
Source. Investment Company Institute. ICI Research Perspective. The role of IRAs in U.S. household savings for retirement, 2019. Figure 23, p. 26. Retrieved from https://www.ici.org/pdf/per25-10.pdf.
As reported in Table 7, withdrawal activity is quite different for account owners before and after age 70. Before age 70, 38% or IRA-owning households took RMD-based withdrawals while 32% took withdrawals based on need. Another 17% took Section 72(t) fixed dollar amount withdrawals. In marked contrast, among account holders age 70 and above, 94% of households took RMD-based withdrawals. Only 3% each took need-based and Section 72(t)-based withdrawals. RMDs are the driving force behind controlling tax deferral of retirement savings.
RMD Withdrawals From Traditional IRAs for by Owners Under Age 70 and Over Age 70 in 2019 (Percent of IRA-Owning Households).
Note. RMD = required minimum distribution; IRA = individual requirement account.
Source. Investment Company Institute. ICI Research Perspective. The role of IRAs in U.S. household savings for retirement, 2019. Figure 24, p. 27. Retrieved from https://www.ici.org/pdf/per25-10.pdf.
Actual RMD Experience
Traditional IRAs are complicated. They may be the participant’s only retirement plan beyond Social Security or they may be supplemental to a DB pension plan and/or a DC retirement plan(s). They may be funded by employee contributions or by rollovers from other DC retirement plans or both.
The discussions related to Tables 3, 4 and 5 used a constant hypothetical account balance of $100,000. That, of course, is unrealistic. The account balance should be reduced each year by the amount of the RMD (as well as being affected by asset-value fluctuations and administrative fees). In theory, the average account balance should gradually decline and eventually disappear.
Tax-deferred IRAs and other DC retirement plans are intended to provide retirement income for the account owner and spouse. They are not intended to pass untaxed wealth to the next generation. However, given the recent growth in the equities and other financial markets, that has often not been the case.
In many IRAs from which only the RMDs are withdrawn, the growth in asset values has kept up with or surpassed the RMD withdrawals for the last decade. Of course, the extent of this will vary from plan to plan due to contributions, withdrawals, asset mix, investment performance and administrative fees. If these factors were held constant, we would get a better picture.
An example is in order. In the early 1980s a taxpayer opened an IRA to supplement his employer-sponsored DB pension plan. He invested in the Fidelity Growth Strategies Fund (FDEGX).
Being rather frugal, a few years later he shifted his supplemental retirement savings to a 403(b) plan (that allowed larger contributions) and stopped contributing to the IRA. The taxpayer made no additional contributions or withdrawals from the IRA account after that until the RMDs took effect.
Over the period 2010 to 2019, Fidelity Growth Strategies Fund had a Morningstar “overall rating” and a “returns rating” of three out of five stars (average). It had a low “net expense ratio” of 0.59% (0.0059) and average annual returns of 12.6%. Not bad.
As indicated in Table 8, by 2009, when the taxpayer turned 70½, the IRA account balance was $5,743. Over the 10-year period, from age 72 through 82, the balance grew from $6,951 to $11,880 even though a total of $4,597 in RMDs were withdrawn.
Actual Experience of a Taxpayer’s IRA Without Additional Contributions or Pre-Age 70½ Withdrawals, 2010 to 2020.
Note. IRA = individual requirement account; RMD = required minimum distribution.
a By email dated January 3, 2020, Fidelity Investments notified the taxpayer that his RMD amount for 2020 had been recalculated based on age 83 and a life expectancy factor of 16.3 citing “IRS RMD regulations.” His date of birth is in the second half of the calendar year.
Source. Personal records of the taxpayer and Internal Revenue Service. Publication 590-B (2018). Distributions from individual retirement arrangements. Appendix B. Table III. p. 61 (Uniform Lifetime Table). Retrieved from https://www.irs.gov/pub/irs-pdf/p590b.pdf.
While this has been wonderful for the account owner and his spouse (and perhaps someday his heirs), it is not quite how RMDs were supposed to work.
The “problem” is the long bull market that followed the Great Recession of 2008–2009 and continues as of this writing (February 2020). It has done wonders for IRAs and other retirement saving plans. Of course, when (not if) the next recession occurs, things will change, at least temporarily.
SECURE Act
The Setting Every Community Up for Retirement Enhancement Act (H.R. 1994; SECURE Act) has been hailed as the most important pension reform legislation enacted since the Pension Reform Act of 2006 (Pub. L. 109-280; PRA).
The SECURE Act passed overwhelmingly in the House of Representatives by a vote of 417 to 3. If the Senate had voted unanimously to pass the bill, it would have been enacted on a fast-track basis. However, it was held up in the Senate by Tom Cruz (R-Texas) over an issue of allowing Section 529 plans to pay for home-schooling expenses. Two other Senators, Mike Lee (R-UT) and Pat Toomey (R-PA), also declined to approve over technical issues.
In late December the SECURE Act bill became Division O of the “must-pass” Further Consolidated Appropriations Act, 2020 (H.R. 1865). It was signed into law by President Trump on December 21, 2019, as Pub. L. 116-94. The effective dates of Division O were not changed. Therefore, many of its provisions became effective almost immediately on January 1, 2020.
Two of the SECURE Act provisions directly affect RMDs. One is changing the age at which RMDs must begin from 70½ to 72 effective January 1, 2020. This change reflects the fact that people are living significantly longer than they did in 1962 when the 70½ age was first adopted. It also recognizes that in 1962 the predominate retirement plan was the employer-sponsored defined-benefit pension with lifetime benefits. It is now the IRA or DC plan that is often exhausted before the owner dies (assuming a lifetime annuity is not purchased).
The second provision effectively eliminates the so-called “stretch IRA.” Before the SECURE Act, a non-spouse beneficiary could stretch the RMDs from an inherited IRA over the beneficiary’s lifetime. Under the new rules the entire inherited retirement account must be withdrawn within 10 years. However, the 10-year rule does not apply to beneficiaries who are (1) disabled or chronically ill, (2) less than 10 years younger than the original account owner or (3) a minor child while still a minor (under 18). This provision is generally effective January 1, 2020. However, government plans have until January 1, 2022, and collectively bargained plans until the earlier of the expiration of the labor agreement or January 1, 2022.
The impact of extending of the age at which RMDs must commence from 70½ to 72 will be modest. About 80% of IRA owners start taking RMDs before reaching age 70½ and take more than the required minimum. Only the 20% of account owners affluent enough to be able to postpone taking RMDs until age 72 will benefit from this change.
Proposed RMD Updates
The RMD tables currently in use are based on life-expectancy data from 2002. 9 Since then, life expectancy at birth has increased by 1.6 years notwithstanding declines in recent years due to the Opioid epidemic. Age-specific life expectancy at 65 has increased by 1.5 years (from 17.9 in 2002 to 19.4 in 2017). 10
On August 31, 2018, President Trump issued Executive Order (EO) 13847 (Strengthening Retirement Security in America). It directed the Secretary of the Treasury (SOT) to determine whether the life-expectancy and distribution-period tables should be updated to reflect current mortality data. It also directed the SOT to determine whether the tables should be updated annually or on some other periodic basis. 11
On November 7, 2019, the IRS released Proposed Regulations to Increase Life Expectancy and Distribution Tables (REG-132210-18). The proposed new tables will allow participants to decrease the amount of their RMDs and therefore increase the amount retained in their IRAs and DC retirement plans. The IRS also proposed updating the tables annually.
Written or electronic comments to the IRS were due by January 7, 2020, and public hearings were held on January 23. When finalized, the proposed new rules are scheduled to go into effect January 1, 2021. 12
The proposed new tables will have minimal impact on RMDs. Roughly 4.6 million or 20.5% will take only the minimum required distribution in 2021. 13 The remaining 79.5% will withdraw more than the required minimum.
Implementation Concerns
By an interesting coincidence, the long-planned and then-delayed SECURE Act provisions and the proposed update of the life expectancy and distribution period tables will take effect at almost, but not quite, simultaneously. Most of the important provisions of the SECURE Act became effective on January 1, 2020. Others are to become effective by January 1, 2022. Meanwhile, the updated IRS life expectancy tables will be effective January 1, 2021. These overlapping implementation dates promise to produce quite a bit of work and expense for IRA and DC retirement plan owners, sponsors and administrators.
Another implementation concern is the proposal to require the update of the life-expectancy table annually. Life-expectancy data do not change that much from year to year. Requiring miniscule changes up or down every year will require a great deal of unnecessary cost and bother. It would be more sensible to update the tables every five or ten years.
Conclusion
RMDs are an essential component of IRAs and DC retirement plans. The intended purpose of such individual retirement arrangements is to encourage retirement savings for the benefit of the account owner and his or her spouse. It is not to transfer untaxed wealth to the next generation. The RMDs are designed to require the timely withdrawals of retirement assets so that they may be taxed.
The recently enacted SECURE Act will not markedly affect the retirement savings of the large majority of IRA and DC plan participants who start receiving distributions early. However, it will benefit those roughly 20% affluent enough to wait until age 72. Similarly, proposed updated RMD tables that will go into effect January 1, 2021, will only marginally reduce the RMD amounts and thereby extend the duration of retirement benefits. However, both of these developments are steps in the right direction and should be welcomed.
Footnotes
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author received no financial support for the research, authorship, and/or publication of this article.
