By: Joey Casolaro, CFP®
As the well-known saying goes, nothing can be said to be certain except death and taxes. The idea of taxation can be traced back to 3000-2800 BC, when the first known taxation system took place in Ancient Egypt. Since then, there have been many changes and additions to the tax laws, with one point remaining certain; no one wants to receive a large tax bill that they weren't expecting.
Starting in the 2022 tax year, the IRS has made a change that will lower specific taxpayers' tax bills going forward. The two caveats to this are it only applies to people who (1) have required minimum distributions (RMDs) from their retirement accounts and (2) do not take out more than their RMD for the year.
So, what is this change, and how will you know if it applies? For the first time since 2012, the IRS has modified the life expectancy tables, which are used to calculate the required minimum distribution (RMD) from your retirement accounts. U.S. tax law requires taxpayers to withdraw annually from traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans (ex. 401k, 403b) once specific rules and ages have been met.
The new tables include a longer life expectancy (since people are living longer) which extends the distribution period of your RMDs, resulting in lower annual RMDs. Below is a chart showing the difference.
The current rules of RMDs are as follows:
RMDs would begin at age 72 if you were born after June 30, 1949
RMDs would begin at age 70.5 if you were born before July 1, 1949
You have until April 1 of the following year to take your first RMD. For each year after that, the RMD must be distributed by December 31. The rules differ for inherited retirement accounts or if you are not a 5% or more company owner. Roth retirement account owners do not have RMDs unless it is an inherited account.
Example -
John turned 72 on July 1, 2021. Since John was born after June 30, 1949, he must take his first RMD by April 1, 2022, to satisfy his RMD for 2021.
John has the following two options:
John can wait until April 1, 2022, to take his 2021 RMD plus his 2022 RMD.
John can take his 2021 RMD before December 31, 2021.
Depending on John's goals and tax situation, option two may be advantageous as this will eliminate the tax implication of having to take two RMDs in 2022, resulting in a lower tax bill for that year.
How to Calculate your RMD
To calculate your RMD, you take the balance of your traditional retirement account as of December 31 of the prior year and divide that amount by the life expectancy factor found in the life expectancy tables provided by the IRS.
It is important to note that there are different tables for different situations. Below is a list of three separate tables that could be used, depending on who is the owner or beneficiary of the account.
Single Life Expectancy Table I: Used if you are a beneficiary of an account (inherited IRA)
Joint and Last Survivor Table II: Used if the sole beneficiary of the account is your spouse and your spouse is more than ten years younger than you
Uniform Lifetime Table III: Used if your spouse is not more than ten years younger or if your spouse is not your sole beneficiary (most used)
Example - using the 2022 Uniform Lifetime Table III above
John (from the example above) and his wife are four years apart in age. John has two traditional IRAs with a balance of $250,000 and $300,000 as of December 31, 2021. Johns 2022 RMD would be calculated as follows: ($250,000 + $300,000)/27.4 = $20,073
Example - using the 2021 and prior Uniform Lifetime Table III above
John (from the example above) and his wife are four years apart in age. John has two traditional IRAs with a balance of $250,000 and $300,000 as of December 31, 2021. Johns 2022 RMD would be calculated as follows: ($250,000 + $300,000)/25.6 = $21,484
As you can see, with the new life expectancy table, John is required to take out $20,073 in 2022 compared to $21,484 using the prior table. This equates to $1,411 less of the ordinary income he will have to report for the 2022 tax year.
*Note: John can take his RMD from one IRA or withdraw different amounts from both. The only requirement is that John takes out the entire $20,073 by December 31, 2022.
Thoughtful tax planning is critical for any financial plan. Please consult with your tax professional before implementing any tax strategy.
Sources: IRS Publication 590-B
Joey Casolaro is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only fiduciary wealth advisory firm that offers comprehensive financial planning, retirement planning, and investment management. Joey graduated from the University of South Florida with a bachelor’s degree in personal finance and successfully passed the CFP national exam in 2021. Joey enjoys working out, spending time outdoors, and hanging out with family and friends in his free time