Change Gets Old

James McGlynn

RETIREMENT RULES seem to get revised almost every year. Whether it’s IRAs, Roth IRAs or Social Security, Congress is constantly rewriting the regulations.

Just think about what’s happened over the past half-a-dozen years. The Bipartisan Budget Act of 2015 eliminated the “file and suspend” option for Social Security recipients. Savvy financial planners would advise clients who had reached their full Social Security retirement age to file for benefits, so their husband or wife could receive spousal benefits. The filers would then suspend their own benefit and continue to accrue delayed retirement credits until age 70.

But the politicians nixed this option, viewing it as unduly beneficial for wealthy and savvy filers. For now, you can still file a “restricted application”—where you apply for spousal benefits, but not benefits based on your own earnings record—but only if you were born before 1954. By 2024, even this loophole will no longer be useful, because those who could take advantage will have reached 70, the oldest age for claiming benefits.

In 2018, the Tax Cuts and Jobs Act eliminated the ability to recharacterize a traditional IRA that had been converted to a Roth. A recharacterization allowed you to reverse the transaction later in the year, which could be advantageous if you were facing a steep tax bill on a large Roth conversion—but the sum converted was now worth substantially less because of a stock market decline.

In 2020, the Secure Act gave us further changes, including ending the stretch IRA for most beneficiaries and raising the starting age for required minimum distributions (RMDs) from 70½ to 72. With the stretch IRA, beneficiaries could draw down an inherited IRA over their life expectancy, thus potentially squeezing decades of extra tax-deferred growth out of the account. Congress viewed this as mostly an estate planning tool for the rich and reduced the deferral period to a maximum 10 years.

What to do? Traditional IRA beneficiaries might withdraw a tenth of the inherited account each year over those 10 years, thereby avoiding the hefty tax bill triggered by withdrawing a large lump sum all at once, which would likely push them into a much higher tax bracket. Meanwhile, those who inherit Roth accounts should leave the account to grow tax-free, only withdrawing the balance at the end of the 10 years.

The 2020 Secure Act also raised the RMD start age from 70½ to 72, giving account holders an additional 18 months to defer distributions. (Even though the RMD beginning age was raised to 72, qualified charitable distributions can still be done starting at age 70½, a strange mismatch that Congress should probably fix.)

By raising the required minimum distribution start age to 72, retirees don’t just enjoy another 18 months of tax deferral. They’ll also have another 18 months to convert part of their IRA to a Roth without worrying about those RMDs. If you convert part of an IRA to a Roth in a year when you’re taking RMDs, the sum converted counts as additional taxable income on top of the required distribution—and will potentially get taxed at a steep rate, making the conversion less appealing.

Coincidentally, the IRS is also updating the life expectancy tables used for determining RMDs, so the calculation starting in 2022 will reflect today’s longer life expectancy. For example, under the current Uniform Lifetime Table, a 72-year-old IRA owner uses a life expectancy of 25.6 years. If you divide 100 by that 25.6, you find that a 72-year-old must typically take a minimum distribution equal to 3.91% of his or her retirement account balance as of the prior year-end. The new calculation in 2022 raises the assumed life expectancy to 27.4 years, thus trimming the required withdrawal to 3.65%.

These two changes—raising the RMD age to 72 and revising the RMD tables to reflect longer life expectancy—result in a reduction in the sum that must be pulled from retirement accounts each year. That means retirees can leave larger amounts in their account as a financial backstop in case they enjoy an especially long life.

What’s next? There’s already bipartisan talk of raising the RMD age again, this time to 75, and potentially exempting IRAs worth $100,000 or less from the RMD rules. Congress has been very good at minor tweaks. What about bigger issues? The politicians haven’t been quite so good at those. Almost nothing has been done to address Social Security’s long-term funding issues, which will loom large a decade or so from now.

James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.

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