New retirement withdrawal rule could backfire in costly way

A new law increasing the age you must withdraw from your retirement accounts may come with some unexpected and expensive consequences.

Retirement legislation President Biden inked in December pushes the age that retirees must start taking required minimum distributions, or RMDs, from IRAs, 401(k)s, and 403(b) plans, to 73 this year, up from 72. That will bump up higher to age 75 in 2033. The delay allows investments to grow tax-free even longer and offers a window to sock more tax-deferred dollars away.

But postponing your RMD may ultimately leave you with larger required annual withdrawals later in life, pushing your income into a higher tax bracket that may affect what you pay in taxes for Social Security or for your Medicare premiums. It could also become a tax headache for heirs.

“The more you push back on the RMD age, the shorter that window to get all of that money out becomes,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance. “And as you stuff more income into a shorter time period, overall you and your beneficiaries are going to end up paying more in taxes.”

RMD rules

You can't keep funds in a retirement plan or a traditional IRA (including SEP and SIMPLE IRAs) indefinitely. Eventually, they must be cashed out and taxed as ordinary income.

The new rule requires that once you hit 73, you have no choice but to start pulling money out with an RMD, which is calculated by dividing your tax-deferred retirement account balance as of Dec. 31 of the preceding year by a life expectancy factor that corresponds with your age in the IRS Uniform Lifetime Table. As your life expectancy declines, the percentage of your assets that must be withdrawn ramps up.

Under the new law, account holders who fail to take an RMD face a 25% penalty on the amount that is not distributed, down from 50%. And if you fix it fast, the penalty is lowered to 10%.

Tax implications

If you have other taxable income in addition to your Social Security benefits, such as your RMD, that can impact how much your benefit might be taxed.