The new law increasing the age at which you must withdraw from your retirement accounts could have some unexpected and expensive consequences.
President Biden in December signed into law raising the age at which retirees must begin taking required minimum distributions, or RMDs, from IRAs, 401(k)s and 403(b) plans to age 73 this year, instead of 72. It will get higher. Be 75 years old in 2033. Deferral allows investments to grow tax-free longer and allows for more tax-deferred dollars to be socked away.
But deferring your RMD can ultimately leave you with larger required annual withdrawals later in life, pushing your income into a higher tax bracket that could affect the taxes you pay or your Medicare premiums. It can also become a tax headache for heirs.
“The further you push back the RMD age, the shorter the window to get all that money out,” New York-based IRA expert Ed Slott told Yahoo Finance. “And because you accumulate more income over a shorter period of time, you and your beneficiaries will pay more in taxes overall.”
You cannot keep funds in a retirement plan or traditional IRA (including SEP and SIMPLE IRAs) indefinitely. Eventually, they must be cashed out and taxed as ordinary income.
The new rule requires that once you reach 73, you have no choice but to start withdrawing money at an RMD, which is calculated by dividing your tax-deferred retirement account balance as of December 31 of the previous year by your life expectancy. which corresponds to your age in the IRS As your life expectancy decreases, the percentage of your assets that must be withdrawn increases.
Under the new law, users who don’t take RMDs face a 25% penalty on the undistributed amount, 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, it can affect how much your benefit may be taxed.
If you file a federal tax return as an individual and your combined income—your adjusted gross income plus tax-free interest earned on investments, plus your half—is between $25,000 and $34,000, you may owe income tax. Up to 50% of your benefits. If you earn more than $34,000, up to 85% of your benefits may be taxable.
For those of you who file a joint return 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 exceeds $44,000, up to 85% of your benefits may be taxable.
What’s more, if you delay withdrawals, your RMD, based on your life expectancy, will be larger, and if tax rates rise, you’ll end up paying a bigger tax bill.
“The trade-off is that there may be higher RMDs later on, and predicting what future income tax rates will be is quite a big game. If they’re higher in the future, they’re going to be worse off than if they took them earlier,” said Eileen O’Connor, a certified financial planner and co-founder of Yahoo Finance.
Slot had a similar attitude.
“People who don’t need the money think they’re saving something by deferring the RMD,” Slott said. “However, in the long run, they may end up paying more tax by waiting until 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 pay more premiums for Medicare Part B and Medicare prescription drug coverage. Standard rates increase for individuals with MAGI above $97,000 and married couples with MAGI of $194,000 or more.
Heirs can feel the sting, too
“The RMD deferral can create a more complex planning environment if heirs are involved, as they must empty inherited IRA distributions over 10 years,” O’Connor said.
The reality is that the more money you leave in a retirement account for your heirs to inherit, the bigger the tax bite will be for them. They are likely to inherit when they are likely to be in the highest tax bracket of their lifetime during their peak earning years. As a result, they will pay more taxes.
“And because it’s now 76.4, they can leave heirs with a lot of IRA assets,” O’Connor said.
Kerry is a senior reporter and columnist for Yahoo Finance. Follow him on Twitter @kerryhannon:.
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