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The Oxford Oracle
Retirees Get Good News From IRS in 2022
You read that correctly. The IRS is finally doing something to slightly improve the tax burden on retirees.
Starting this year, the Required Minimum Distribution ("RMD") on tax-deferred retirement accounts will result in slightly lower forced distributions from these accounts. Lower distributions means lower dollar amounts subject to tax. The change is due to new assumptions on life expectancy.
Increased Life Expectancy
For the first time in 20 years, the Internal Revenue Service has updated its actuarial tables that dictate how much a person is required to withdraw from his or her retirement accounts starting at age 72. 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.
For an age 72 retiree the new assumed life expectancy is now 27.4 years, vs. 25.6 years under the old rules. This results in an effective RMD rate of 3.6% starting in 2022 vs. 3.9% under the old tables. On a $1 million IRA balance, this amounts to $2,566 fewer dollars that must be withdrawn and subject to taxation. So not a huge change, but an improvement nonetheless.
While COVID-19 did negatively impact life expectancy, the longer-term trends are still positive over the past 20 years. Changes to actuarial tables take time, but it was clear that a change was needed.
Other Changes Affecting Retirees
In a similar vein, retirees got some help from Congress as part of the 2019 SECURE Act. This law changed the age at which retirees must begin taking RMDs from age 70.5 to age 72. This has allowed money in tax-deferred retirement accounts to stay invested longer before mandatory distributions must begin. Again, not a huge change, but a favorable one for retirees.
Interplay With Social Security
While these two changes have been good news, retirees are still getting hurt when it comes to taxation of Social Security benefits.
Retirement account withdrawals, including those forced on retirees by RMDs, are taxable as ordinary income. This occurred as part of legislation passed by Congress in 1993. Today, for a married couple filing a joint return and showing taxable income of more than $44,000, up to 85 percent of your benefits may be taxable.
While this law isn't new, it is increasingly affecting more and more retirees. Why? Because Congress never indexed for inflation the level at which taxes start to apply on Social Security benefits. If Congress had indexed for inflation at even a modest 3%, the actual income level at which Social Security benefits would be taxable should be over $139,000!
While the combination of SECURE Act age changes plus the new RMD tables will help defer taxes a bit longer, retirees are still being hit by stealth tax increases on Social Security benefits.
If all of this sounds confusing, you're not alone.
We've been helping clients prepare for, and thrive in retirement for over three decades. Our clients' continued financial success is exceeded only by their success at the game of life.
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