For the first time since 2002, the Internal Revenue Service has updated its Uniform Lifetime Table and lowered the size of RMDs. The new tables, which now project longer lifespans, are used to calculate RMDs from individual retirement accounts, 401(k)s and other retirement savings vehicles each year. This means that starting in 2022, retirees can keep more money in a tax-deferred retirement account.
What Are RMDs and How Are They Calculated?
Traditional IRAs and 401(k)s allow retirement savers to defer taxes until they withdraw money from their accounts. This allows the money to continue to grow at a faster rate over time. The IRS does, however, require you to withdraw a specific amount each year once you reach a certain age. This limits you from keeping the funds in a retirement account forever.
The following accounts are subject to RMDs: Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, 457(b) plans, profit sharing plans, other defined contribution plans. Roth IRAs are not subject to RMDs.
To calculate your RMD, first, look up the market value of your retirement account as of Dec. 31 from the previous year. Then, divide that value by the distribution period figure that corresponds with your age on the IRS Uniform Lifetime Table. For example, a 72-year-old retiree with $500,000 in her IRA would divide $500,000 by her distribution period figure, which is 27.4. As a result, she would be required to withdraw at least $18,248 from her IRA in 2022.
Why The New RMD Formula Is Good For Retirees
The IRS has raised the average life expectancy from 82.4 to 84.6. With a higher life expectancy, retirees will likely need to spread their assets over more years. Due to the need to cover additional years, RMDs that begin in 2022 will be less than they were under the previous formula.
Since smaller withdrawals will be required each year, more of your retirement assets can remain in an IRA, 401(k) or tax-deferred account. Smaller RMDs will lessen your tax liability and could potentially drop you into a lower tax bracket – good news for retirees or those subject to RMDs.
Under the previous Uniform Lifetime Table, a 72-year-old with $500,000 in her 401(k) would have been required to withdraw $19,531 ($500,000/25.6) during her first year of taking RMDs. That’s $1,283 more that would have been subject to income taxes compared to the smaller minimum withdrawal required under the revised table.
Meanwhile, a 72-year-old with $2 million in his retirement account would have been required to withdraw $78,125 under the older formula ($2 million/25.6). However, the updated formula results in an initial RMD of just $72,992 ($2 million/27.4), meaning this retiree would keep an extra $5,133 growing tax-deferred in his retirement account.
In summary, for the first time since 2002, the IRS updated the actuarial tables that determine the amount of money a person must withdraw from their IRA or 401(k) at a certain age. The SECURE Act changed the RMD age from 70.5 to 72 and the updated Uniform Lifetime Table has lowered the size of RMDs. This allows you to keep more of your assets in a tax-deferred account. Remember, RMDs are only the minimum amount that must be withdrawn each year. You can always withdraw more from an IRA or 401(k), but keep in mind: the larger the distribution, the larger your tax bill.