Retirement is a daunting prospect for most employees, with the loss of income causing a massive shift in lifestyle and spending habits. This is why people save for retirement while working.
However, saving for retirement is easier said than done and not every employee has access to employer-supported retirement plans that give them access to post-retirement money pool. But that might change now.
On August 31, President Trump issued an executive order that impacts the Department of Labor and the Department of Treasury to work for several bipartisan changes that change how retirements plan operate.
What Did The Executive Order State
To summarize what the executive order stated, the President addressed the Departments of Labor and Treasury to analyze and potentially change these things:
- The age limit when people with traditional IRAs (Individual Retirement Accounts) and employer-supported 401(k)s must start taking Required Minimum Distributions (RMDs) – which currently stands at 70 ½ . And/or
- Reducing the RMDs once they start
- Consider creating a pool of Multiple Employer Plans, which would allow small companies to offer financial institutions backed 401 (k) plans. The participants to this plan will be pooled from multiple unaffiliated and small business employers, instead of asking such employers to create their own independent 401 (k) plan from scratch.
- Review the administrative requirements, including excessive paperwork, for employers’ workplace requirement plans in order to proceed with the intention of lowering costs and push forward retirement plan adoption among the small and medium-sized
What Is An RMD (Required Minimum Distribution)
For starters, if you are enrolled in a traditional retirement scheme like the IRA or 401 (k) – the Internal Revenue Service (IRS) states that you withdraw a minimum amount of savings each year from those accounts. The withdrawal amount is based on the total balance held in those accounts, which means the more you have saved, the more you may take out once that age is reached.
On the other hand, if you do not withdraw the minimum account – IRS charges you with a penalty which is roughly equal to 50% of the minimum account you are required to take out.
The RMD was initiated so that people don’t look to accumulate retirement savings by not withdrawing from tax-advantaged accounts – basically allowing for years of tax-advantaged accumulation passed down as inheritance.
In this way, the IRS was able to collect some sort of income tax revenue after letting those savings grow tax-deferred for years.
What Changes For You In 2019
The Department of Treasury bases the RMD age limit on the life expectancy ratio calculated in 2002. The average life expectancy ratio since then has changed from 77 to 78 ½. The US Chamber of Commerce has called for the RMD age to be stretched out to 75 to keep up with the evolving labor market.
With increased lifespans, not updating the RMD age limit means that there is a risk that RMDs will deplete retirement savings accounts too quickly.
However, the fact remains that life expectancy increases have been nominal – translating to a nominal change in RMD.
When taken into perspective, these RMD proposals don’t look to make a material difference for most clients of financial advisors as;
- RMDs on a $50,000 is relatively small, and
- IRA contributions must only pertain to earned income, and even then it may still not be enough to offset RMD.
There have been reservations that such a change can lead to a decrease in the quality of life retirees enjoy. As they delay withdrawals, they will save and restrict payment until the required date.
Since the changes are yet to be enacted, the impact on current retirees still remains unclear. People who have already started RMDs remain perplexed as to how some will go about this. People under 73-75 will be able to pause them.
For people who are expecting to start with RMDs, it may mean they don’t have to start them as early as expected. For people who are already into their retired lives, once the executive order is enacted, they will face lower RMD requirements.
Contrastingly, some argue that increasing the RMD start date will encourage individuals that otherwise procrastinate on retirement planning and savings, to save during their early retirement years, given that they are expected to live longer.
For people with IRA and 401 (k) accounts, their taxable income will be increased due to these mandatory withdrawals. Additionally, adding those few years of tax-deferred growth can have a favorable impact on the amount of savings for the people.
What is important to be noted is that Trump’s executive order does not warrant any change. The Treasury will take ample time to act on the order, and the findings may differ the original predictions. However, it is one thing to keep an eye on, that will potentially impact millions of employees.