Workplace 401(k) accounts and IRA accounts are two of the best types of retirement investment accounts because of the tax advantages they provide. But each comes with a big disadvantage.
The accounts are subject to Required Minimum Distribution (RMD) rules. Starting at age 72, you must begin taking a certain amount of money out of your investment account whether you want to or not.
This can cause financial complications because you'll owe taxes on the distributed funds; you'll be subject to big penalties if you don't take out the mandated funds; and you may end up getting pushed into a higher tax bracket due to the distribution increasing your income. If your income goes high enough because of your RMD, this could also make part of your Social Security benefits taxable or increase the taxes that you pay on benefits.
The good news is, lawmakers are currently considering legislation that would change RMD rules to mitigate some of the big downsides. Here's what you need to know about the proposal.
Will the painful RMD rules be changed to lessen the damage?
The legislation that is currently under consideration is called the Securing a Strong Retirement Act of 2021.
It would make two big changes to the current RMD rules, both of which could help retirees who are currently dissatisfied with having to take money out on the schedule the government has set up for them.
Specifically, the act would:
- Change the age when RMDs begin. As mentioned above, seniors must begin taking RMDs at age 72 under the current rules. The Act would change this so RMDs wouldn't have to start until 73. Furthermore, beginning in 2029, retirees wouldn't need to begin taking RMDs until age 74, and in 2032 the required age would be pushed back even further so they wouldn't have to begin until age 75.
- Reduce the penalties for failure to take RMDs: Right now, retirees who don't take out the mandated funds from their 401(k) or IRA on schedule are subject to a penalty equaling 50% of the amount they should've withdrawn. The Securing a Strong Retirement Act would change this penalty, reducing it to 25% down from 50%. And, if retirees corrected their error in a timely manner, then the penalty would be reduced even further -- all the way down to 10%.
These two changes alone would make RMD rules far less painful for seniors, since they would have more flexibility for more years in when they take out money. And those who aren't aware of these complicated rules wouldn't face such dire financial consequences for not following them.
Now, there's no guarantee that the Securing a Strong Retirement Act of 2021 will end up being signed into law. However, there's reason to believe the bill's future is promising. The legislation passed the House Ways and Means Committee by unanimous vote in May, which means it received bipartisan support.
While it was stalled as a result of lawmakers shifting their attention to passing President Biden's proposed Build Back Better Plan -- which would have included broader changes to retirement savings programs -- Build Back Better doesn't appear to be making much progress, so it's possible that this bipartisan plan will be embraced instead.
Of course, if you want to avoid RMDs regardless of what lawmakers do, you also have other options -- such as investing in Roth IRA accounts instead.