The pending tax legislation, poised to pass Congress as part of the 2020 budget deal, includes the SECURE Act, which makes a number of retirement tax changes. Among those are two consequential changes in the required minimum distribution (RMD) rules for IRAs and other qualified plans like 401(k)s:
- The minimum age at which RMDs apply is increased from age 70.5 to age 72; and
- “Stretch IRAs” (applying to IRAs inherited from someone other than a spouse) are limited to a 10-year period, rather than the recipient’s life expectancy.
As I noted in a previous post, these provisions will automatically decrease (#1) or increase (#2) Minnesota state income tax revenues, just as they will have those same effects on federal revenues. I assume Congress was using #2, the new limits on stretch IRAs, as a way to offset the revenue losses under other SECURE Act provisions. But I’m perplexed as to the policy rationale for increasing the minimum age for RMDs.
Congressional documents do not state a rationale. One might guess that it was based on a concern that more people are working after 70.5 and so should not be required to start taking IRA distributions until later. Or that some individuals with small IRAs should not be required to start draining them if they have other resources, such as wages or pensions. (My cynical view: the financial institutions who receive fees for holding and managing retirement accounts likely lobbied for the change. Because of those fees, they surely view policies that augment balances in those accounts, such as looser RMD rules, to be in their interest.)
If either of those were the rationale, Congress should have limited the age increase to individuals who still have material labor earnings or small IRA balances (e.g., less than $200k or something like that). (RMDs don’t apply to a 401(k) if you’re still working for the employer.) That would have prevented the main effect of the change – which seems nonsensical to me – giving holders of large IRAs who don’t need to take distributions one or two more years of tax deferral.
Most IRA holders don’t have the luxury of deferring distributions until RMDs apply; they need to take money out of their IRA to live on. The age increase will mainly be a boon to upper income IRA holders. By contrast, the limits on stretch IRAs move in the opposite direction, since this modestly reduces the income tax benefits of inherited IRAs, especially for younger beneficiaries. One would assume that disproportionately will hit heirs of those with big IRAs.
In other words, Congress seems to pushing policy in opposite directions with its two RMD policy changes. One rationale for RMDs is to prevent affluent individuals from just stockpiling money, tax deferred in their IRAs and, then, passing them on to their heirs. (Treasury regulations describe the purpose of RMDs as “to ensure that the
favorable tax treatment afforded a qualified plan is used primarily to provide retirement
income to a participant and a designated beneficiary, rather than to increase the estate
of a participant.”) The taxes would be deferred longer (without RMDs or with lower RMDs), and the heirs frequently will be in lower tax brackets to boot. Here, the age increase allows deferring more taxes by the IRA holder, while the limits on stretch IRAs require heirs to pay their taxes more quickly.
To me, a couple of interesting elements of the age change are (1) going to a full year (age 72) rather than a half year (70.5) and (2) the likely unintended effect on qualified charitable distributions for some in the year when they turn 72.
Going to a full year means that people born after July 1, 1949 with birthdays in the first half of the calendar year will get two extra years of deferral, while those with birthdays in the second half of the year will only get one more year. I’m not sure why the current regime uses 70.5 years (rather than 70 or 71), since the RMD is set based on the account value at the end of the prior year and distributions can be taken at any time during the taxable year or up until April 1 of the following year. Thus, it isn’t an administrative issue. A little mystery I have never tried to track down. But whatever the reason, Congress has decided to change it.
A quirky effect on qualified charitable distributions (or QCDs) is more concerning and something that I doubt the relevant congressional staffers thought about. The law (not changed by the SECURE Act) allows an individual who is subject to RMDs in a traditional IRA to have distributions (up to $100,000 per year) be paid directly to a charity. Making a QCD avoids the distributions from being included in the IRA holder/taxpayer’s income. That, as has been widely noted, is preferable to making an itemized deduction for a contribution, since it keeps the distribution totally out of your income (e.g., no need to forgo the standard deduction and doesn’t count toward any of the AGI limits, etc.). But in the first year RMDs apply, a QCD can only be made after the taxpayer meets the age requirement. See IRS Publication 590 which (mirroring the statutory language) says “You must be at least age 70½ when the distribution was made.” That will become 72 when the SECURE Act is signed into law. Thus, along with being able to defer taxes longer means that younger IRA holders will need to wait one or two more years before they can use QCD to make their charitable contributions.
Note how this could be a problem if your birthday is late in December. Assume your birthday is on December 30th, which is a Saturday in the year you turn 72. Qualified distributions are made by requesting the trustee of the IRA to cut a check to the charity. That check must be dated on or after the birthday on which you turn age 72 to qualify – i.e., on or after December 30th in this case. That effectively means the QCD will be made in the next calendar year (and tax year for a calendar year taxpayer, which virtually all individuals are). That in itself isn’t a big deal, since RMDs for the first year can be taken up until April 1 of the following year and still meet the requirement. (Unlike claiming an itemized deduction for a charitable contribution, it doesn’t need to be made in the taxable year. All you are doing is keeping the distribution out of your income.) Thus, the charity can receive the check in the next calendar year and the taxpayer can still exclude it from his or her income, IF the April 1st deadline is met AND the taxpayer gets a qualifying receipt from the charity. That is where the rub may come in, since charities typically issue those receipts on a calendar year cycle. They may have to make adjustments to accommodate people with birthdays very late in the calendar year who become subject to RMDs in that calendar year, so they can satisfy the IRS documentation requirements.
One might assume that it is concerns like this that led to the use of half year (70.5) rule. But 70.5 age was set well before QCDs were even a thing.
Congress could fix this by allowing QCDs to be made any time a qualifying RMD can be taken (i.e., at any time during the taxable year when the taxpayer becomes subject to RMDs). Why Congress required taxpayers to meet the minimum age requirement before making a QCD when a similar requirement does not apply to RMDs themselves is unclear to me.
Dated: December 19, 2019
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