FA Magazine March 2023 - Page 30

James G . Blase

Are Extended RMDs A Gold Mine Or Tax Trap ?

The SECURE Act 2.0 extended required minimum distributions . For couples , it might not make sense to wait .


HE FIRST SECURE ACT EXTENDED THE BEGINNING DATE for taking required minimum distributions from the year after the account owner reaches age 70½ until they reach age 72 . Just three years later , “ SECURE Act 2.0 ” has extended this age to 73 , and offers a further provision for extending it again , to age 75 , beginning in 2033 .
The question for financial advisors is whether these new “ extensions ” are a gold mine for their clients or a trap for the unwary ( or at least unwary married couples ).
The most important principle to consider here is the difference in the way Congress taxes couples and single individuals . The income level at which singles reach their tax bracket thresholds is half that of married people filing jointly , while the standard deduction for singles is also half as high .
Let ’ s take , for example , a retired couple who have reached 70½ this year . They will eventually have a required minimum distribution of $ 89,450 from their combined $ 2 million-plus in IRAs . ( We ’ re using the 2023 tax brackets and standard deductions and assuming these don ’ t change in the future ). The couple also receive $ 27,700 in interest and dividend income during the year , which is exactly equal to the standard deduction for a married couple filing jointly . In this scenario , which is not at all unusual , the federal income tax liability of the couple , had they voluntarily withdrawn the $ 89,450 this year , would be $ 10,294 ( not taking into account the taxes on their Social Security benefits ).
Now let ’ s say the couple elect not to withdraw the $ 89,450 during 2023 .
The question for financial advisors is whether these new “ extensions ” are a gold mine for their clients or a trap for the unwary ( or at least unwary married couples ).
Instead , they wait until one spouse dies . The surviving spouse then withdraws that $ 89,450 a year after becoming widowed . Look at what happens : The survivor ’ s federal income tax liability , on the same $ 89,450 amount , rises to $ 18,192 , or almost 77 % higher than what the tax liability would have been had the couple not taken advantage of the new extension rules ( again , not taking into account taxes on Social Security ).
Now multiply this almost $ 8,000 difference in federal tax liability by three years , beginning this year ( or by up to five years , beginning in 2033 ). The point is that the surviving spouse would be subject to federal income taxes on IRA distributions at a rate that ’ s higher than what the couple would have been subject to while both spouses were still alive . This is sometimes called the “ single filer penalty .”
Given the fact that some spouses survive their partner by 10 years or more , and the fact that RMD percentages increase as one gets older , the total difference in income tax liability resulting from the single filer penalty can be considerable , before state income taxes are even considered .
What ’ s more , as a result of “ SECURE Act 1.0 ,” the couple ’ s children are also likely to face a higher income tax rate on what is left in their parents ’ IRA when both pass on . That ’ s because the children are likely to be in their peak earning years at that point as a result of SECURE Act 1.0 ’ s