How the Secure Act Could Trigger Higher Taxes for Some Retirees

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At first glance, legislation passed by the House of Representatives that gradually raises the age to 75 for required minimum distributions of tax-deferred accounts seems like a glittering retirement present for seniors. If enacted—the bill must still pass the Senate—the new rule will allow many retirees to delay taxation of a significant chunk of their wealth for another three years.

But some retirement experts say the legislation will result in many seniors paying higher taxes over the long run. “It’s going to raise the lifetime taxes for a fair number of people,” says Boston University economist Laurence Kotlifkoff, who also sells retirement-planning software. That’s because the delay will result in higher required minimum distributions, or RMDs, for “a large number of people” when they do take them, pushing them into higher tax brackets, Kotlifkoff says.

Under current law, retirees must begin withdrawing money from individual retirement accounts, 401(k)s, and other tax-deferred accounts at age 72. The House on Tuesday, by a bipartisan vote of 414-5, approved the Secure Act. 2.0, which would raise the age for beginning RMDs to 73 next year, 74 in 2030, and 75 in 2033.

William Reichenstein, head of research for Social Security Solutions, also believes that delayed RMDs will result in higher lifetime taxes. Reichenstein did a calculation for a 72-year-old retiree with a $3 million tax-deferred account. If that retiree began RMDs immediately, he would withdraw $109,489 to meet the requirement. If he waits until age 75, assuming 6% annual growth in his investments, the RMD would rise to $145,246. Not only does the money have more time to grow, but the RMD rate at age 75 is currently 4.07%, compared with a 3.65% rate at age 72.

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The required distributions grew by about $35,750, Reichenstein notes, adding “you might not only be in a higher tax bracket but you could also be forced to pay higher Medicare premiums for several years going forward.”

Indeed, large RMDs can cause huge tax problems for retirees who accumulated much of their wealth in tax-deferred accounts during their working years. Whereas RMDs can push higher-income retirees into higher tax brackets and Medicare brackets, they often result in higher taxation of Social Security benefits for middle-income retirees.  

Of course, RMDs don’t prevent retirees from withdrawing money far earlier. Some retirees begin taking money out of their accounts at age 59½, the minimum age for withdrawals without paying a 10% penalty in most circumstances. But others, particularly those who have large pensions or Social Security benefits, or those who have saved a lot of money in after-tax accounts, don’t touch their tax-deferred accounts until required.

If Congress delays the age for RMDs, many are going to wait even longer before pulling money out of tax-deferred accounts. That may be a mixed blessing for them when it comes to taxes.

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