A new law that increases the age at which you must withdraw from your retirement accounts could have unexpected and costly consequences.
President Biden signed in December moves the age at which retirees must begin taking required minimum distributions, or RMDs, from IRAs, 401(k)s and 403(b) plans to 73 this year, from 72. That will increase to age 75 in 2033. Deferral allows investments to grow even longer tax-free and offers the opportunity to repay more tax-deferred dollars.
But delaying your RMD can end up leaving you with larger required annual withdrawals later in life, pushing your income into a higher tax bracket that can affect how much you pay in taxes for or on your Medicare premiums. It could also become a tax headache for heirs.
“The more you withdraw relative to the age of the RMD, the shorter the period to get all that money out,” Ed Slott, a New York-based IRA expert, told Yahoo Finance. “And as you inject more revenue into a shorter period of time, overall, you and your beneficiaries end up paying more in taxes.”
You cannot keep funds in a retirement plan or traditional IRA (including SEP and SIMPLE IRA) indefinitely. Ultimately, they must be cashed out and taxed as ordinary income.
The new rule requires that once you reach age 73, you have no choice but to start withdrawing money using RMDs, which are calculated by dividing your tax-deferred retirement account balance as of December 31 of the previous year by a life expectancy factor that matches your age at the IRS As your life expectancy decreases, the percentage of your assets that must be withdrawn increases.
Under the new law, account holders who don’t take RMDs face a penalty of 25% on the amount not distributed, up from 50%. And if you fix it quickly, the penalty is reduced to 10%.
If you have other taxable income in addition to your Social Security benefits, such as your RMD, that can affect how much your benefit might be taxed.
If you file your federal tax return as an individual and your combined income — your adjusted gross income, plus tax-free interest earned on investments, plus one-half of your — is between $25,000 and $34,000, you may have to pay income tax on up to 50 % of your benefits. If you earn more than $34,000, up to 85% of your benefits can be taxable.
For those of you who file jointly and have a combined income between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. If your combined income is more than $44,000, up to 85% of your benefits can be taxable.
Furthermore, if you delay taking funds, your RMD based on your declining life expectancy will be higher, and if tax rates increase, you’ll end up paying a higher tax bill.
“The trade-off is that there could be higher RMDs later and guessing what future income tax rates will be is a pretty big gamble.” If they’re higher in the future, they’d be worse off than if you took them earlier,” Eileen O’Connor, a certified financial planner and co-founder of Yahoo Finance, told Yahoo Finance.
Slott had a similar view.
“People who don’t need the money think they’re saving something by delaying RMDs,” Slott said. “But in the long run, they may end up paying more taxes by waiting until age 73 and taking only minimum distributions.”
Potential impact on Medicare premiums
Delaying your RMD can also have consequences for your Medicare premiums. are based on your modified adjusted gross income, or MAGI. That’s your total adjusted gross income plus tax-free interest.
Simply put, if you have a higher income, you may end up paying an extra amount in premiums for Medicare Part B and Medicare prescription drug coverage. Standard rates increase for individuals with MAGI above $97,000 and for married couples with MAGI of $194,000 or more.
Heirs can also feel the sting
“Delaying RMDs can create a more difficult planning environment if heirs are involved because they need to exhaust inherited IRA distributions within 10 years,” O’Connor said.
The reality is that the more money you leave in a retirement account for your heirs to inherit, the higher the tax burden on them. They are likely to inherit when they are likely to be in the highest tax bracket of their lives during their peak earning years. As a result, they will end up paying more taxes.
“And since it’s now 76.4, they could leave a lot of assets to IRA heirs,” O’Connor said.
Kerri is a senior reporter and columnist at Yahoo Finance. Follow her on Twitter @kerrihannon.
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