Richard L. Kaplan, the Guy Raymond Jones Chair in Law at Illinois, is an internationally recognized expert on U.S. tax policy and retirement issues. In an interview with News Bureau business and law editor Phil Ciciora, he discusses potential changes to when senior citizens must tap their retirement accounts.
President Trump signed an executive order requiring the government review the rules that require retirement plan owners to begin withdrawing funds from retirement accounts at age 70 ½. What are the rules regarding such accounts, and why is this review necessary?
Tax law has long required that investors in almost all retirement savings plans begin taking funds out of their plans starting at age 70 ½ or face a prohibitive penalty of 50 percent of the amount that should have been withdrawn.
The rules exist in the first place because retirement savings plans such as 401(k) plans, individual retirement accounts and other defined-contribution retirement arrangements provide significant tax benefits to encourage people to save for their retirement. Specifically, no income tax is due on amounts contributed to these plans or on investment earnings until funds are withdrawn from the plans. The so-called “required minimum distribution” rules make sure that these plans are used to fund the owner’s retirement rather than the heirs’ inheritance.
How do these rules operate?
Every year after reaching age 70 ½, the account owner must withdraw and pay tax on an amount equal to the account’s ending balance for the prior year divided by a life expectancy factor from a table that the Internal Revenue Service prescribes for this purpose. The math is really not very challenging, and most financial service companies that offer these accounts will handle the mechanics of it once an account owner tells them to start the withdrawal process.
Why is there suddenly interest in reviewing these rules?
In some sense, it’s another Baby Boomer phenomenon. Many, but certainly not most, account owners are now reaching age 70 ½ and finding that they do not need to take money out of their retirement accounts to live on. They might have funds from other sources, such as Social Security, or perhaps they are still working full- or part-time. Increasing longevity is another factor. Several years ago, I published an article explaining that the triggering age of 70 ½ for starting required minimum distributions was established in 1982, and that adjusting that age for the increase in life expectancy since then would bring it closer to 75 years old.
Is it possible that an adjustment to age 75 will be made this year?
The triggering age was set by statute, so the Trump administration cannot change it administratively. Moreover, Congress is very unlikely to take up any tax legislation before the mid-term elections in November, but it is quite possible that this change might be enacted during a post-election lame-duck session. For that reason, it’s something that retirees need to monitor.
With people living longer, does it make sense to enact more sweeping changes not only to defined-contribution plans, but also to entitlements such as Social Security?
Raising the retirement age for Social Security beneficiaries has certainly happened in the past, but not since 1983.
When Social Security was first enacted, the average life expectancy in this country was 61.4 years. If we were to adjust Social Security’s retirement age to account for the increase in longevity, the new retirement age would be 82.
On the other hand, the increase in life expectancy is not universal. Lower-income, less educated people have generally not experienced as great of an increase as higher-income, more educated people.
In any case, President Trump said during the 2016 campaign that he did not want to change Social Security, and the high political sensitivity of changes to this very popular program make any alteration of its retirement age extremely unlikely.
Editor’s note: To contact Richard L. Kaplan, 217-333-2499; email rkaplan@illinois.edu.
