In the last few months, two of my colleagues’ grandmothers passed away, both past the age of 100. While living such a long life is still an outlier, Americans are, in fact, living longer, despite the COVID-related drop in life expectancy in 2020. Living longer is an inspiring goal for many of us, but the fantasy of living until you’re 101 overlooks a hidden truth: no one wants to outlive their money.
Last November, the IRS updated life expectancy tables to account for generally longer life spans, and this update goes into effect at the beginning of 2022. This is the first update to IRS tables in nearly 20 years and coupled with the SECURE Act changes of December 2019 – which raised the required minimum distribution (RMD) age from 70.5 to 72 – we have some new rules coming into play regarding retirement planning in a relatively short span of time.
For some background, the IRS uses three life expectancy tables to calculate Required Minimum Distributions (RMDs).
The Uniform Lifetime Table
This is the table most used by plan owners. It is used to determine lifetime RMDs for most plan participants over the age of 72, including when a spousal beneficiary is a sole designated beneficiary and not over 10 years younger than the account owner, or when the spouse is not the sole designated beneficiary. The Uniform Lifetime Table is also used to calculate distributions required for an individual who has inherited a tax deferred retirement account from their spouse and has selected to transfer the account into their own name.
The Joint and Last Survivor Table
This is only used to determine RMDs for plan participants over the age of 72 when a spouse is a sole designated beneficiary and is over 10 years younger than the account owner.
The Single Life Table
Following the SECURE Act, this will be used by a newly defined class of beneficiaries called Eligible Designated Beneficiaries. Eligible Designated Beneficiaries are defined as spouses, disabled or chronically ill individuals, minor children of the account owner/participant, or someone who is no more than 10 years younger than the account owner/participant.
As a result of the new IRS RMD tables, which become effective at the beginning of 2022, retirees will have a smaller required payment over a greater number of years. This translates to more tax-deferred growth and the opportunity for reduced taxable income each year. The updated IRS tables reflect a relatively minor change, so many account holders may not even notice the decrease, but there is some benefit to those who only distribute the minimum required amount each year.
A few things to remember: inherited IRA RMDs do not change, and the updated IRS tables will not change the new SECURE Act rules related to required minimum distributions for most non-spouse beneficiaries of inherited IRAs and associated retirement plans. The account is expected to be depleted over a 10-year period following the year of death.
RMDs reflect the amount required to be distributed. Owners and beneficiaries can always withdraw more than the required amount. It’s often advantageous to take similar amounts from your IRA each year and avoid large lump sum distributions potentially subject to higher marginal tax brackets. You should revisit your IRA distribution strategy each year in conjunction with your long-term spending needs and overall tax situation.
Front-Loading v. Back-Loading
There are many ways to determine your RMD strategy, but two main options are front-loading and back-loading. As the names suggest, these strategies center around when you want to spend the bulk of your retirement savings. People who decide to front-load believe it’s better to spend more money early in retirement, then cut their spending later as they need to. This plan considers that a younger retiree will likely be healthier and better able to enjoy a higher standard of living and spend money on things like travel, for example.
Conversely, people who choose to back-load presume that because they may live longer than they expect to, their current spending plan won’t last them long enough. Spending less earlier in their retirement may reduce any burden to their children later and allow them to keep the same standard of living during advanced age.
How to Choose?
The decision between front- and back-loading requires more than mere crystal ball gazing. The trade-off here illustrates one of many risks and assumptions in planning for retirement: not knowing how long you will live. Given an unknown life expectancy, a primary objective is finding the balance between not outliving your money and maximizing your financial resources to realize your spending goals.
My financial planning colleagues and I typically try to find that middle-ground for clients. How little spending are you willing to accept today so you won’t deplete your assets during this longer life expectancy? How can we mitigate your worries about outliving your assets with smart planning? These are not easy questions to answer, but with a little insight into our clients’ values, we can find a solution that works.
The unknowns in financial planning are always the challenge. For every story about a grandparent celebrating a century on earth, financial advisors can share another story of a client’s health deteriorating more quickly than expected and the resultant increase in health care costs becoming burdensome to their children. It is crucial to find the balance between saving and spending that will bring the most joy, peace, and confidence, no matter how long a life we are given.
CFP®, Senior Wealth Advisor