December 23, 2022
One not so good item in the package of retirement fund provisions in the omnibus funding bill raises the age for mandatory distributions from retirement accounts from 72 to 75. This is phased in over a decade, but it does go up immediately to 73 in 2023. It had already been raised from 70.5 years to 72 years in 2019.
The mandatory distribution requirement is based on life expectancy at your current age. This means, for example, if your life expectancy at 72 is ten years, then you have to withdraw (and pay taxes) on roughly 10 percent of the money in your IRA or 401(k). The actual calculations are somewhat more complicated, but this is the basic story.
Anyhow, the ostensible justification for raising the age for mandatory withdrawals was that people are worried about outliving their retirement funds. It is important to realize that this is not really the issue with mandatory withdrawals.
The mandate doesn’t require that people spend the money from their accounts, it just requires they pay taxes on them. This means, for example, if someone had $70,000 in their retirement account (roughly the median for account holders in their sixties, which is a bit more than half the population), and their required distribution was 10 percent, they would have to pull $7,000 out of their account.
They could put this $7,000 into another investment account, they would just have to pay taxes on this money as though it were normal income. The vast majority of retirees would be paying a tax rate of 10 or 12 percent, which means they would owe $700 to $840 in taxes. The rest of the money could be invested for their later years.
Since they would have to pay taxes on their money when they pulled it out in any case, the only loss is the potential investment income from their tax payments. That is not likely to be a major factor in determining whether they will outlive their retirement savings.
There are of course people in higher tax brackets, especially among those in a position to defer withdrawals from their retirement accounts. For someone in the top 37 percent tax bracket, deferring withdrawals can mean large savings. But it is unlikely that these people are actually worried about outliving their retirement accounts.
For these higher income people, this provision is simply one more way to reduce their tax obligations, as were provisions in the bill that raised caps on contributions. Since very few people were contributing at the current caps, raising the caps is simply a way for high income people to shelter more of their income from taxation.
These giveaways to high income people may have been a price worth paying for the other changes in retirement provisions, such as making the savers credit fully refundable so that low income people can benefit, and also requiring most employers to contribute to their workers’ retirement. However, we should be clear that these provisions are designed so that they will only benefit a small group of people at the top of the income distribution. They are not about making it less likely that middle income people will outlive their retirement savings.