The passage of the SECURE 2.0 Act will result in some major changes to the required minimum distribution (RMD) rules. The RMD rules affect qualified retirement plans (for example, 401(k) and 403(b) private employer-sponsored retirement plans), the Thrift Savings Plan (TSP) and traditional IRAs.
Moreover, the Secure 2.0 Act of 2022 will make significant changes the way Americans save for and are taxed in retirement. One of the major areas of helping individuals save for retirement is in reforming the RMD rules. This column discusses how TSP participants will be affected by the new RMD rules.
The new RMD rules are especially significant for employees who are in their later years of federal service and getting close to retiring from federal service. It is important for these employees to know how the new TSP RMD rules will impact them in order to better plan their retirement. Being familiar with the new TSP RMD rules at this time will hopefully prevent any mistake at the time TSP RMDs begin.
Age When TSP RMDs Must Begin
Prior to the passage of the SECURE 1.0 Act in December 2019 (with an effective date of January 1, 2020), TSP participants must have started taking their RMDs from their TSP by April 1st following the later of the year they became age 70.5 or the year they retired from federal service.
Traditional IRA owners (but not Roth IRA owners) had to take their first traditional IRA RMD no later than April 1st following the year they became age 70.5. The SECURE Act 1.0 Act and the SECURE 2.0 Act passages eventually pushes the age for starting RMDs to age 75.
Under SECURE Act 1.0, the TSP required beginning date (RBD) (the date that federal employees must take their first TSP RMD) for employees born after June 30, 1949 is April 1st following the later of the year they become age 72 or the year they retire from federal service. Under the SECURE 2.0 Act, the RBD increases in a two-step process.
The two-steps are:
• Step 1. Beginning 1/1/2023, the RBD for federal employees born after December 31, 1950 is April 1st following the later of the year they become age 73 or retire from federal service, and
• Step 2. Beginning 1/1/2033, the RBD for federal employees born after December 31, 1959 is April 1st following the later of the year they become age 75 or retire from federal service.
Relief on RMD Penalties
There is an IRS penalty for not taking an RMD or not taking enough of an RMD from a traditional IRA or from a qualified retirement account. The IRS penalty is a 50 percent excise tax on the distribution shortfall. There is currently some penalty relief available. An individual who must take an RMD can avoid the 50 percent excise tax penalty if the failure to take an RMD was due to “reasonable error” such as a serious illness.
To request a penalty waiver, an individual must fill out and submit IRS Form 5329 (Additional Taxes on Qualified Plans Including IRAs, and Other Tax-Favored Account). A statement should be attached explaining why the individual did not take his or her RMD or why there was an insufficient amount of the RMD taken.
The current 50 percent excise tax is one of the stiffest penalties in the entire Internal Revenue Code. It is no surprise therefore that many members of Congress wanted to reduce the penalty. The SECURE 2.0 Act reduces the penalty to 25 percent in all cases. In addition, the penalty reduces to 10 percent if a qualified retirement plan participant or traditional IRA owner takes a particular year’s RMD by the end of the second year following the year it was due.
The following example illustrates:
Example 1. Alex was born August 31, 1949 and owns a traditional IRA. Since Alex was over age 72 during 2022, he was required to take his 2022 IRA RMD no later than December 31, 2022. But Alex failed to take his 2022 tradition IRA RMD. If Alex withdraws the entire amount of his 2022 traditional IRA RMD by December 31, 2024, his excise penalty on his traditional IRA RMD shortfall will be reduced to 10 percent.
No More RMDs for Roth 401(k) Account (Including the Roth TSP)
Under current IRS rules, a Roth IRA is the only type of retirement account that is not subject to RMDs while the Roth IRA owner is alive. However, RMDs are currently required for Roth 401(k) retirement accounts, and this includes the Roth TSP.
What does it mean that a Roth TSP account is subject to the RMD rules? Does it mean that if a TSP participant owns both a traditional TSP account and a Roth TSP account that a separate RMD must be taken from each TSP account?
No, this is not the case. Instead, it means that when the TSP computes a TSP participant’s RMD, the TSP combines the balance in the TSP participant’s traditional TSP account and the TSP participant’s Roth TSP account (the balance as of December 31 of the year preceding the year’s RMD) and then divides that balance by a life expectancy factor.
The life expectancy factor is from the IRS’ Uniform Lifetime Table (found in IRS Publication 590-B). When the TSP participant is notified by the TSP of his or her TSP RMD for that year, the participant can fulfill that year’s TSP RMD by withdrawing from the Roth TSP, the traditional TSP or a combination of each. The following example illustrates:
Example 2. Margaret, age 73 during the year 2022, is a retired federal employee (retired in 2020) with both a traditional TSP account and a Roth TSP account. For the year 2022, Margaret had to take a TSP RMD. Her 2022 TSP RMD was calculated by the TSP. Margaret was notified by the TSP in January 2022 as to the amount of her 2022 TSP RMD, calculated as follows:
Step 1. Margaret’s Traditional TSP balance as of 12/31/2021: $650,000 Margaret’s Roth TSP balance as of 12/31/2021: $250,000
Total TSP account balance as of 12/31/2021 equals $650,000 plus $250,000 equals $900,000
Step 2: Margaret’s life expectancy factor (age 73) from the IRS Uniform Lifetime Table equals 26.5 years
Step 3: Divide Step 1 by Step 2 – $900,000/26.5 equals $33,962. This is Margaret’s 2022 TSP RMD
Margaret can fulfill her 2022 TSP RMD of $33,962 by withdrawing from her traditional TSP account (fully taxable), from her Roth TSP account (fully nontaxable), or a combination from both her traditional TSP account and her Roth TSP account.
TSP participants can get around the current Roth TSP RMD requirement by rolling over the entire Roth TSP account to a Roth IRA. A word of caution: If the Roth TSP account is not “qualified”, then the Roth TSP participant who rolls over his or her unqualified Roth TSP account to a Roth IRA may have to wait up to five years to pull their money out of the “rollover” Roth IRA tax-free.
A Roth TSP account is considered “qualified” when the Roth TSP participant fulfills two requirements, namely
(1) He or she is at least age 59.5; and
(2) It has been at least 5 years from January 1st of the year the Roth TSP participant made his or her first Roth TSP contribution (the Roth TSP became available to federal employees at most agencies in the year 2012).
The SECURE 2.0 Act does away with the need to rollover funds from the Roth TSP to a Roth IRA. Instead, as with Roth IRAs, Roth 401(k)s (including the Roth TSP) will not be subject to the RMD rules before the Roth TSP participant dies. This change generally kicks in starting in 2024.
However, an exception applies to RMDs required before 2024 but not required to be paid until January 1, 2024 or later.
SEE ALSO: No Lifetime RMDs for Roth TSP Participants: Ramifications for Current and Future Federal Retirees
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER®, Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019