Congress’s rapid response to the COVID-19 recession contained an unnecessary gift to the elder rich. As a result, post-COVID retirement security will be even more unequal. On one end of the spectrum, desperate older people will claim Social Security earlier or sell their retirement assets at a depressed valuation. Many of the lowest-educated older people will lose their jobs permanently. At the same time, Congress has suspended the required minimum distribution or RMD, essentially cutting taxes for the top 2%* of older households.
What is a RMD?
In order to incentivize retirement saving, the U.S. tax code defers taxes for numerous retirement savings vehicles, including 401(k)s, inherited retirement accounts, 403(b)s and 457(b) accounts. But in order to keep the wealthy from abusing the tax-deferred status of these accounts indefinitely, retirees in their early 70s must begin making annual required minimum distributions (RMDs) from their accounts. The CARES Act suspended these distributions for 2020. Those whose first RMDs would have been for tax year 2019 can skip both 2019 and 2020.
According to Forbes contributor Jaime Hopkins, the suspension of all RMDs from retirement accounts for 2020 was the most important change in the CARES Act for elders. And it was not for the elders who really needed help. Who does it help? The biggest beneficiaries will be the so-called IRA millionaires (think Mitt Romney). They and their heirs just got a break from taxes, precious taxpayer money that could go to seniors who actually need the help.
Wealthy elders will not owe any RMDs for 2020, inherited or otherwise. As investigative journalist Gerald Scorse points out, this same tax break for the wealthiest savers also appeared in the 2008 stimulus package.
For most people the RMD is irrelevant. Most elderly live primarily on Social Security and the median retirement balance for people nearing retirement is $15,000. So the minimum one needs to withdraw out of one’s tax-free retirement account at 70 to avoid penalties is a non-issue. But for some, the RMD takes away a tax break well-off people would prefer to keep. Our new research shows that by the time people are age 70, at best 7% of the highest income older households have over $400,000 in their IRA or 401(k)- type plan. Just 2% have more than $800,000.
RMDs have a public purpose
The point of the RMDs is that Congress did not intend tax-favored retirement funds to be tax-free indefinitely. People with a lot of money in their accounts may think, “I don’t like RMDs, I want to leave my money sit in a tax-free account for my heirs or later.” That thinking conveniently forgets the reason the money is tax-free in the first place. Much of the accumulation is not the individual saver’s money but is essentially the public’s money in taxes not collected. Taxes not collected for special reasons are called tax expenditures—revenue losses attributable to special exclusions, exemptions, deductions, credits, etc.
Retirement money was given a special tax break for a special reason. The government will decline to collect $1.4 trillion in income tax between 2018-2022 in order to encourage a public purpose: retirement saving. Congress does not intend to have the wealthy among us defer taxes forever. At some point federal income taxes on your withdrawals are due. Contributions to a retirement account such as a traditional IRA or 401(k) was made pre-tax to encourage Americans build a nest egg. But the new rules suspending RMDs means the top 2% get more tax-deferral.
The bottom line: In extending the RMD, Congress has given a wet kiss to very wealthy retirees while failing to move to boost Social Security benefits, extend unemployment benefits to older workers who may lose their jobs permanently, or lower the Medicare eligibility age.
*How did I compute only 2% of the wealthiest households get the RMD suspension benefit? Here goes. Our research uses gold-plated data from the University of Michigan and the Social Security administration. Unlike all other research that takes snapshot of people in their 60s and makes assumptions about the rich and poor we examine people who have been lower income their whole life, middle class for most of their lives and high income most of their lives. Some low income – not many have substantial retirement savings but it would be inaccurate to call them rich. Most people nearing retirement have little to nothing in retirement assets, their $100,000 is likely to be quite dwindled by the time they are 70. Twenty-five percent of middle class people have more than $100,000 in their retirement accounts by the time they are over the age of 52; Half of upper class people have more than $100,000 by the time they are over age 52 and most older people in the top twenty percent of the lifelong income level have that much money.
** The RMD rules apply traditional IRAs, Simplified Employee Pension (SEP) IRAs, Savings Incentive Match Plan for Employees (SIMPLE) IRAs, 401(k)s, nonprofit 403(b) plans, government 457 plans, profit-sharing plans and other defined contribution plans. (Roth IRAs, which are funded with after-tax contributions, don’t require RMDs until after the owner dies.) here are slightly different rules for people who are still working in their 70s — rare birds (tenured professors etc.)
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