Personal Finance

How living longer can pay off for these retirees

Key Points
  • If you're 70½ or older, or you've inherited a retirement account, you're probably already familiar with required minimum distributions.
  • RMDs are the amount you're required to take from tax-deferred accounts each year.
  • A new proposal would change how those withdrawals are calculated because people are living longer.
Senior man celebrates his 90th birthday
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A change proposed by the IRS could alter how much retirees are required to withdraw each year from their traditional retirement accounts.

The reason? People are living longer now than when the agency last issued its tables for required minimum distributions in 2002.

As a result, the IRS is likely to bump up average life expectancy estimates slightly, which will reduce the annual amount individuals age 70½ and over must take from their retirement and other tax-deferred accounts.

Right now, it's just a proposal. The IRS and Treasury Department came up with it after an executive order from President Donald Trump instructed the agencies to take a look at the issue.

The changes would take effect starting in 2021. Here's a breakdown of what it could mean for you.

What is an RMD?

A required minimum distribution, or RMD, is the amount of money that individuals who are 70½ or over must take out of their retirement accounts, or other tax-deferred accounts such as certain annuities, each year.

That includes most IRAs, as well as other retirement plan accounts, such as 401(k) plans. Of note, Roth IRAs, which are funded with post-tax money, do not require these withdrawals until the owner of the account dies.

Individuals who inherit those IRA accounts must also take RMDs.

The amount you are required to withdraw is based on life expectancy and distribution tables from the IRS. Most individuals rely on their financial institutions to calculate the amount each year.

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What would change?

The changes would extend the possible ages that are used in the calculations.

For example, the current tables for IRA owners now only go up to 115 years of age. That would be bumped up to 120 under the proposed changes. Inherited account owners would also get bumped to 120, from 111.

Calculating for longer lives will mean one thing: smaller minimum withdrawals from your accounts each year.

"People will save a little money, and their IRA will last a little longer because of the increase in life expectancy, which decreases RMDs and decreases taxes a little," said Ed Slott, CPA and founder of Ed Slott & Co.

How much will I save?

A 75-year-old with $100,000 in retirement savings would be required to take out $4,367 this year, based on a 22.9-year life expectancy, according to Slott.

Once their life expectancy shifts to 24.6 years under the proposal, the minimum amount they would be required to withdraw would be $4,065.

That's a $302 difference. Assuming a 25% tax rate, they would save about $75 in taxes, Slott said.

If that 75-year-old had $1 million instead, their RMD would be reduced to $40,650 from $43,668 after the changes go through.

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That individual would take out $3,018 less and save about $750 in taxes.

"Everybody saves a little," Slott said. "They save it every year, so the IRA technically lasts a little longer."

Not all individuals will notice the difference, however. That's because about 80% of savers take out more than their RMD each year, said Erica York, economist at the Center for Federal Tax Policy at the Tax Foundation.

"They would be unaffected by a change in the rule," York said.

The people who would stand to benefit the most would be individuals with other income who are not relying on their retirement accounts for day-to-day living expenses, she said.

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Will the proposal likely go through?

The proposal is up for a comment period. However, it is not anticipated that it will be met with much, if any, opposition.

A report from Treasury estimated that distributions would be reduced by about $8.1 billion in 2021 with the changes. That's a very small amount of the total retirement income that's taxable, York said. In comparison, the IRS reported $1.2 trillion in taxable retirement income in 2016.

"I don't see any real reason why the proposed changes wouldn't go ahead and take effect in 2021," York said.